Oil prices will be the trigger for stocks in the week ahead.
The Fed meets Tuesday, but it is not expected to take any action on interest rates and the meeting is expected to be uneventful. As usual, traders will watch for nuances in the Fed's post-meeting statement. Earnings from a few big names, like AIG and Procter & Gamble are expected, but otherwise there is a relatively quiet stream of economic data.
Oil, however, remains a top catalyst for stocks and a flare-up or big move down could set the trend for equities. Key for the energy market is how Iran responds to U.N. demands to end its nuclear program.
Volatility promises to be the daily theme, as the debate continues over whether the market is forming a bottom or ready to retest the July lows.
Stocks Troubled for Now
"We find it difficult to believe there is a sustainable upside for this market," said Abhijit Chakrabortti, Morgan Stanley's chief equities strategist.
Chakrabortti, in a phone interview, said he sees three key concerns: slowing growth outside the U.S., weakening corporate profits and inflation.
"We're far more negative on non-U.S. growth than on U.S. growth," he said.
He said he does not expect improvement in the earnings picture or the non-U.S. economies in the next six months, but that is not the case with inflation.
"Right now in our view is the next few readings will remain high because of energy and food prices, and the feed-through from that. This is the area we see abating most," he said.
But ultimately, this could become a good-news scenario for stocks, particularly into 2009. The slowdown in other parts of the world, like Brazil and India, will ultimately add strength to the dollar and should continue to bring down the price of commodities. This trend ultimately will be good for U.S. stocks, as a slowdown in inflation will reduce pressure on corporate profit margins.
But for now, the earnings scenario is worsening: "It's our view that profit margin deterioration is now underway," he said.
Chakrabortti said he believes a good level to be constructive on the market at is 1150 to 1200 on the S&P 500. He also believes that the market could still rally back to 1300 to 1350 by year-end, if his expectations for inflation and the dollar play out as he envisions.
Chakrabortti said some of his favorite stocks are in health care, which he says were very undervalued. He likes Schering-Plough , Abbott , Teva , Bristol-Myers and Amgen , as well as some of the big consumer staple companies, like Coca-Cola and Colgate-Palmolive . He also likes select financials including JP Morgan and Bank of New York .
(Morgan Stanley has or could have business relations with these companies, or own stock in them. Chakrabortti personally owns JP Morgan.)
"We are very bearish on materials and very bearish on the global industrial outlook," Chakrabortti said.
The Dow finished the past week at 11,326, with just a 44-point decline but that was after several days of violent moves up and down. The S&P 500 was up 2.55 or 0.2 percent to 1260. Crude oil rose $184 per barrel or 1.5 percent for the week to end at $125.10. The 10-year Treasury added 1-10/32 points, lowering its yield to 3.948 percent and the two-year was yielding 2.516 percent.
The Federal Reserve's one-day meeting Tuesday is the big economic event of the week. There is also a smattering of data throughout the week, with personal income and factory orders Monday, and ISM nonmanufacturing data Tuesday. On Thursday, weekly jobless claims are released along with pending home sales and consumer credit. Productivity and costs and wholesale trade are reported Friday.
"I think the Fed is looking at (Friday's) jobs numbers and Thursday's GDP as a reflection of stimulus payments that are working their way out of the system. I think they are very unlikely to raise interest rates," said Jared Bernstein, senior economist with Economic Policy Institute.
"I think they are going to continue to accentuate and maybe even ratchet up the kind of headwinds language they've used."
"The threats are there on the inflationary side, but that's an itch they know they really can't scratch," he added, noting that it's weak demand that will have to bring down gas prices and have.
"They can't poke for oil. They can't plant food. They can only restrain demand, and that's the last thing you'd want to do given the conditions in the job market," Bernstein said.
"I don't think they're going to do anything...But I do think you could see (Fed Chairman Ben) Bernanke's foot move from hovering over the brake to hovering over the accelerator," said Bernstein.
Of the data expected this week, Bernstein says he's looking at productivity, which he expects to be a strong number. He is also looking closely at pending home sales. "There does seem to be a bottom being carved out," he said -- although plenty of others say the bottom in housing is a long way off.
Ka-Ching! Is the Greenback on a Comeback?
Important for the dollar in the week ahead will be not only the Fed's comments, but also rate meetings Thursday by the Bank of England and the European Central Bank. In the past week, the dollar gained 1 percent against the euro, its third weekly gain against the European currency.
Marc Chandler, chief currency strategist at Brown Brothers Harriman, said he thinks the dollar has bottomed against major currencies. "We think the dollar's cyclical downturn is over, and in the next couple of months, the dollar will continue to get traction as the market begins pricing in an ECB rate cut and a Federal Reserve rate hike," said Chandler.
Many think the ECB's next move will be to hike rates, but Chandler says the slowing Eurozone economy and drop in commodities prices could get the ECB rethinking that course of action. He does not expect to see any move by the ECB when it meets Thursday, but the comments from ECB President Jean Claude Trichet could be telling.
Chandler says the dollar was punished by the Fed's flexibility with rates during the credit crises, but now other countries will have to face the same issues.
"The less flexible economies may have a more protracted and deeper downturn," he said. His target for the dollar against the euro at year end is $1.47. "It's not all that wild-eyed. Once the turn comes, it's going to be significant," he said.
Battle in the Pits
Triple-digit up and down Dow moves in back-to-back sessions have begun to feel a little routine after the past week. Traders who trade options in the Chicago pits say it looks like that volatility is here to stay for the time being. (The CBOE had a record volume month in July, by the way.)
"As soon as the stock market looks like it's starting to trend one way, we have both sets of players in here, and that's confusing," said Doug Prskalo, who trades options on the S&P 500 with Blue Capital Group.
"It would be weeks at a time, where you'd see the same kind of orders coming into the crowd. Now what's happening on a day-to-day basis, is big sellers are coming in and big buyers are coming in."
He said they are duking it out over the 1200 to 1300 range on the S&P.
"It's getting narrower and scarier because we're driving down to 1200. Whenever the market gets to the 1220 area, market volatility increases and we see paper flow out here on the downside," he said.
Prskalo said that on Monday, if the S&P gets to 1250, it could trade down to near 1200 again.
Nearly three quarters of the S&P 500 have reported and 66 are set to report earnings in the week ahead.
Some of the key names reporting include Anadarko Petroleum and Humana Monday. Cisco, Duke Energy, News Corp., Procter & Gamble, and Archer Daniels report Tuesday. On Wednesday, Dow component AIG reports, as does Freddie Mac, Marsh & McLennan, Time Warner, Transocean and Sprint Nextel. Thursday's reports include Barr Pharmaceuticals, Williams Cos, Toyota and Sempra Energy.
Friday is a big day for Warren Buffett watchers, when Berkshire Hathaway reports.
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