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.
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.
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.