That’s the key question facing income investors as Wall Street heads into its traditional Labor Day break. This summer--for the fourth consecutive year--interest rates have backed off sharply after spiking in the spring. With today’s action, the 10-year yield has again cut below 4.8 percent, half a percentage point lower than its peak for the year.

In response, income investments across the board have rallied sharply, particularly during the past few weeks. Utility stocks have recovered all the ground lost last year and have moved to new highs.

Ditto real estate investment trusts, Canadian royalty and income trusts and a host of other yield-oriented investments.

After panicking in the spring and bailing out, investors once again can’t seem to get enough of big dividend-payers. And the enthusiasm is even spreading to long neglected sectors like telecommunications.

Suddenly, no one is worried about inflation anymore and the watchword is safety plus dividends.

As a result, the low prices we saw for income investments across the board in spring and early summer are no more. Instead, we’re seeing the same kind of lofty valuations for “safe” investments that we saw a year ago.

One case is point is the story of IDACORP (NYSE: IDA). For the past four years, the Idaho-based electric utility has been recovering from a 1990s diversification strategy that went sour. As have most troubled utilities, the company has been able to retrench to its core regulated business, paying down debt and patching things up with regulators.

The ute is now the healthiest it’s been in some years. The stock, however, is now trading at some 21 times trailing earnings and with a yield of barely 3 percent--levels not even achieved during the power market boom of the ’90s--despite very modest growth. And its story is far from unique.

Investors are paying high prices for stocks like IdaCorp for one

reason: a perceived degree of safety in an increasingly uncertain economic environment. Ironically, by bidding these stocks up to such high prices, they’ve dramatically increased the risk of disappointment that could send these shares radically lower. A single-minded pursuit of safety in other words has brought great risk.

A big part of the bet on safety is the growing belief that the US economy is slowing down, and that recession--not inflation--is the greatest threat. To be sure, there’s evidence that things are cooling off. The housing market, for example, has noticeably slowed in many regions as home sales and new home building have been tapering off. And several of the more economically sensitive companies posted lackluster second quarter profits.

Wall Street has largely gone from hounding Federal Reserve Chairman Ben Bernanke about not doing enough to fight inflation to worrying that the central bank has already gone too far and may need to cut interest rates. Many now perceive the Fed’s pause in its upward push on rates as a first step to doing just that.

If we continue to see more signs of slowing growth in the US and around the world in coming weeks, speculation that rates are coming down again will only grow. In fact, the inverted yield curve itself--shorter-term interest rates greater than longer-term ones--illustrates that investors expect slowing growth, if not a recession, and falling inflation.

That, in turn, will continue to push up the prices of high-quality stocks, particularly those with high yields. If, however, the economy seems to steady and inflation picks up, even the highest-quality plays could again lose ground in a hurry.

At this point, it’s tough to say which of these scenarios will play out, or if something else entirely will emerge. It’s quite possible, for example, that the yield curve will remain inverted and inflation will pick up steam as commodity-price increases filter through to the rest of the economy. In that case, it would be very hard even for high-quality income investments to make much headway, and the broad market would almost surely falter.

In addition, what happens to rates is likely to be heavily influenced by two wild cards. One is energy prices.

We’ve heard for many months now why a major drop in oil prices is inevitable. Forecasts of $50 or even single-digit oil prices have gotten a lot of play, and every dip in black gold is trumped up in the financial press as the beginning of the end.

The bear arguments for oil center on two suppositions, first that current inventory supplies are more than ample, and second, that the only things holding up prices are a political premium attached to oil by nervous investors and the desire of various hedge funds to beef up their commodity exposure.

As the theory goes, eventually the political premium will diminish to the extent that hedge funds will want to reduce their commodity exposure. At that point, oil and other commodity futures will be dumped en masse and prices will crater.

If oil prices should go into a power dive, it would be bad news for energy-oriented investments. Worst hit would be US trusts like BP PRUDHOE BAY (NYSE: BPT) and the smaller Canadian royalty trusts. But even super oils like CHEVRON (NYSE: CVX) and EXXONMOBIL (NYSE: XOM) could take a knock in the near term.

On the other hand, stocks in other sectors would almost surely take off, as falling commodity prices zap out the inflation from the economy. That would give the Fed the leeway to cut interest rates.

Most income investments would thrive under such a scenario, though it’s possible some, like IdaCorp, could pull back as investors put less of a premium on safety.

There’s a lot to like about such an outcome. Unfortunately, it basically hinges on the improbable, that somehow global markets would no longer demand a high political premium for oil.

Basically, today’s political premium is a product of very tight energy supplies around the globe. During the ’90s when there was a supply glut, the relative impact of one country taking its output off line was minor. In contrast, today virtually any interruption anywhere is enough to impact energy prices.

In other words, tight supplies mean a high political premium. That will only change when there’s a fundamental shift in the balance of power between energy producers and consumers. And that’s highly unlikely until we see at least some of the same factors that ended the last bull market for energy in the ’70s: a lot more conservation, widespread use of alternative energy, at least one major new discovery of conventional oil/gas reserves (like the North Sea of the ’70s) and very likely a global recession.

At present, none of these factors are much in evidence. SUVs and other gas guzzling cars are still selling like hotcakes, while except on the coasts hybrid vehicles are scarce. The huge amount of ethanol produced in this country is being primarily used as an additive to gasoline, rather than a pure alternative, and new nuclear plants are years away at best. The only major new discoveries are of nonconventional reserves, which require high oil prices to be economic. And there’s no stomach among the world’s central banks to bring on an early ’80s-style recession, particularly with overall inflation still relatively well behaved.

The bottom line is high and volatile energy prices are going to be with us for a while. That’s a good reason to keep some energy stocks in your portfolio, no matter how high prices go. And it’s also a pretty good reason why there will be at least some premium attached to safety in the markets--even if we avoid a devastating hurricane in the Gulf of Mexico this year.

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The other wild card for investors this year is the upcoming November mid-term election. As my colleague Elliott Gue

This time around, the level of tension could well be a lot greater than usual. A host of straws in the wind are pointing to the ruling Republicans losing at least one and possibly both houses of Congress. The non-partisan Cook Political Report--which has been a reliable forecaster of races over the past couple of decades--has identified 27 endangered Republican incumbents in the US House of Representatives. That’s up from just nine at this point in the 2004 election cycle and it’s not counting open seats, where challengers’

chances are even greater.

Based on where races stand now, we could also see a 50-50 split in the US Senate, as well as Republican governors falling in a half-dozen states. Even the GOP’s fund raising advantage is rapidly shrinking as industry hedges its bets. And the most blistering critiques of President Bush are coming from his erstwhile allies on the right via talk radio and Fox News.

We’re still more than two months from the election and, as the old saying in politics goes, the real campaigning doesn’t begin until after Labor Day. But if the current trend does hold up through September, the action could get quite choppy indeed by Halloween, as investors worry about the risks of life under a new government.

All else equal, political tension will only reinforce the premium placed on safety. However, we could see pressure on regulated industries--particularly utilities in battleground states like Maryland--if there’s a perception the rules are about to change for the worse due to a switch in the governor’s mansion. Note this isn’t a real concern on the federal level regardless of the outcome in November, since the executive branch, rather than the legislature carries out utility regulation.

The bottom line is that rising prices for income investments certainly beat the alternative. But now’s no time for complacency.

In fact, high prices make now a good time to sell out the weak from your holdings, or to lighten up on stocks that have appreciated to become an inordinately large portion of your portfolio.

As for strategy, whenever there are several plausible outcomes, it’s always a good idea to have at least some holdings in your portfolio that will benefit from each possibility. Energy stocks may take a bath if the bears are correct even for a short time. But they should also hold their own if inflation picks up or if there’s greater than usual pre-election turmoil. Safety-first utility stocks won’t do so well if oil drops and investors start flocking to growth stocks. But they’ll continue to lead the market as long as economic growth remains subdued, or slows further.

There ought to be a common denominator for the securities you own:

Each should be backed by a company with a growing business that will become more valuable over time. In an environment like this, it’s easy to guess wrong on the market, the economy or both. But as long as you own quality, you’ll always be in the game, and that’s more than half the battle when it comes to successful long-term investing.