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Week Ahead: Follow the Bond Insurers

Housing numbers, inflation data and lots of Fed speak loom large for markets but it may be the fate of bond insurers that really drive the direction of trading in the week ahead.

Fed Chairman Ben Bernanke gives his monetary policy report to the House Financial Services committee Wednesday, starting at 10 a.m., then again on Thursday to the Senate Banking Committee. There are also some big earnings on tap, including insurer AIG and Home Depot.

There will be a lot of attention paid to the fate of the monoline insurers Ambac and MBIA. The two have been trying to work out ways to bolster capital levels to head off potential downgrades by ratings agencies.

CNBC's Charlie Gasparino reported late Friday that Ambac is making progress and may have a deal with bankers by Monday or Tuesday. Stocks immediately bolted higher, with the Dow moving 200 points to close 96 points higher.

Traders say many investors scrambled to reverse short positions in anticipation a deal could be worked out over the weekend. If a deal is worked out, traders say it would be bullish for stocks. Wall Street has worried a downgrade of the bond insurers would be a direct hit on banks, which have credit exposure to the insurers. For instance, Citigroup said in an SEC filing its exposure totaled $4.02 billion at year end.

"C" Words

Three "c" words ever prevalent in this market are credit, commodities and correction. The first two are a big concern right now, and occasionally result in the third. Traders and analysts repeatedly discuss the likelihood that stocks will retest lows before breaking out of this choppy trading cycle.

I spoke to Merrill Lynch's Richard Bernstein a few days ago. He expects the stock market to stay choppy awhile, and says it could retest or even set new lows.

"I would say the volatility is telling you the leadership is changing," he said. What's this mean for investors? According to Bernstein, the market is in a period where it's best to stay in large cap stocks, high quality bonds, defensive sectors, developed markets and investments with quality dividends as the credit bubble is worked out. He said the old growth stories were credit driven. "Every investment story around the world was a story about something that had access to easy credit," he said.

Stock picking is more difficult in this type of environment. "The probability of hitting a winner goes down. It's harder to get a winner, but the payoff will be greater," he said.

"It's a good argument for ETFs," he said.

Hot Commodities

Commodities were on a tear in the past week, sparking fears that inflation is taking hold just as the economy slows down. More than few economists have raised the idea that the economy could be heading for stagflation.

Bernstein made an interesting point in a report he issued this past week. First, he warned that energy stocks could be heading into a period where they will underperform. He says the sentiment toward the sector is extremely bullish even as fundamentals start to erode.

One point he made was that some investors see the Fed giving up its inflation fighting stance as it cuts rates deeply. But he says the credit contraction means that some of these inflation concerns are overdone. "Without credit extended to create excess money, the theory argues, it is impossible to abnormally stimulate demand for goods and get price increases," he wrote.

He also points out that credit is a leading indicator and some theorists see it as a leading indicator for inflation. Therefore, he notes, it may not be the right time to structure equity holdings by overweighting sectors with expectations of future inflation.

"This probably explains why the Fed is being so aggressive despite the consensus that inflation is a significant problem. Simply put, they are easing in hope of offsetting a serious credit crunch, and believe that inflation is not an issue when credit is not being extended," he wrote.

CNBC's Rick Santelli, who spends his time in the Chicago futures pits, says ironically it was the treatment of credit as a commodity that in fact caused a lot of the market's current problems. "Credit was just as much a commodity as gold and oil and that particular commodity was underpriced. Now that it's moving up in price, it's now being rationed and that's what we're experiencing. Cheap credit really did commoditize credit," he said.

Market Mayhem, Econorama

Market Mayhem

The Dow, helped by Friday's turnaround, eked out a 0.27 percent gain for the week. The Nasdaq lost 0.79 percent and the S&P 500 was up 0.23 percent. The best performing S&P sector for the week was energy, up 2.67 percent. Materials were next, up 2 percent, and financials had a 1 percent gain. Telecom stocks were the biggest losers, down 6.2 percent. Other major sector indices showed gold stocks up 8.2 percent. Airlines were down 5.2 percent on rising energy prices and as a major deal failed to materialize in the past week.

In market action this past week, gold rose 4.6 percent to $944.70 per troy ounce, a $41.90 move. Silver rose 5.4 percent to $18.0250 per troy ounce and copper soared 7.6 percent to $3.787 per pound.

Oil revisited $100 per barrel this past week and in fact set a new high above $101 per barrel. It finished the week at $98.81, up 3.47 percent. Gasoline was up 1.6 percent at $4.5337 per gallon.

Econorama

Lots of housing data is on the agenda in the week ahead, starting with existing home sales Monday at 10 a.m. On Tuesday, the story is all about housing prices. There is the OFHEO fourth quarter home price index at 10 a.m. and the S&P Case Shiller data for the top 20 metro areas, released at 9 a.m. New home sales data is released at 10 a.m. Wednesday.

Inflation data in the week ahead will be key for markets. Producer price inflation data is released Tuesday at 8:30 and the pce deflator is reported Friday morning.

Consumer confidence is released that day at 10 a.m. as is the Richmond Fed Survey. Durable goods are released Wednesday at 8:30 a.m.

Weekly jobless claims and fourth quarter GDP are released Thursday at 8:30 a.m. Personal income and spending and PCE price index are issued Friday at 8:30. The Chicago purchasing managers are released that day at 9:45. Consumer sentiment is reported at 10 a.m. Friday.

Besides the two days of testimony by Bernanke, other Fed officials are speaking. Fed Vice Chairman Donald Kohn speaks Tuesday at 12:15 p.m. on the U.S. economy and monetary policy at the University of North Carolina. he will take questions from the audience.

Fed Governor Randall Kroszner speaks in New York Monday at a convention of risk professionals at 9:50 a.m. Fed Governor Fredric Mishkin speaks on stabilizing inflation in Greenville, N.C. Monday at 3:30 p.m. and on financial literacy Wednesday at 10 a.m. in Washington. On Friday, he speaks on lessons from the mortgage meltdown in New York at 11 a.m.

This weekend, governors from across America meet in Washington at the National Governors Association's winter meeting. They are talking about clean energy and surface transportation, but you can bet they will be discussing the impact of credit market conditions on public finance. The governors meet with President Bush Monday.

Earnings Central

There are still a few big earnings reports rolling in, including some major retailers. Lowe's and Nordstrom report Monday, while Home Depot , Macy's and Target report Tuesday, and the Limited reports Wednesday. The Gap and Kohl's report Thursday.

Autozone , Heinz , Sirius and CBS report Tuesday. Toll Brothers reports Wednesday, and Sprint, Dell and AIG report Thursday. Warren Buffett's Berkshire Hathaway reports Friday.

In other corporate news, BMO Capital Markets holds a global metals/mining conference in Florida Monday and Tuesday. Goldman Sachs technology conference is underway in Las Vegas from Tuesday to Thursday.

J.P. Morgan hosts its investor day Wednesday. Wachovia's homebuilding and building products conference is Wednesday to Friday, and the Jefferies internet conference is Wednesday

Questions? Comments? marketinsider@cnbc.com

  • Patti Domm

    Patti Domm is CNBC Executive Editor, News, responsible for news coverage of the markets and economy.

  • A CNBC reporter since 1990, Bob Pisani covers Wall Street from the floor of the New York Stock Exchange.

  • CNBC's Senior Personal Finance Correspondent

  • JeeYeon Park is a writer for CNBC.com. Follow her on Twitter: @JeeYeonParkCNBC

  • Rick Santelli joined CNBC Business News as an on-air editor in 1999, reporting live from the floor of the Chicago Board of Trade.

  • Senior Producer at CNBC's Breaking News Desk.