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Wall Street Week Ahead: Politics Overshadow Profits

Stocks could be in for a rough ride in the week ahead as a focus on political risk overshadows what is clearly an improving profit picture.

Oliver Quilla for CNBC.com

About a quarter of the S&P 500 companies report, but the emphasis will be on what goes on in Washington. Fed Chairman Ben Bernanke faces a very tight confirmation vote later in the week, and President Obama delivers his State of the Union address Wednesday night. There is also a Fed meeting and several major economic reports, including fresh housing data and fourth quarter GDP.

So far, nearly 20 percent of the S&P 500 has reported and 78 percent of those companies have beaten estimates, according to Thomson Reuters. Yet, stocks ignored the positives and sold off in the worst selling spree since the market bottomed in early March.

The Dow lost 4.1 percent or 436 points for the week to end at 10,172, while the S&P 500 fell 3.9 percent to 1091. The S&P saw its worst three-day decline since March 9, but it is still up 61 percent since that day. The Dow had its worst week since March 6. Stocks fell, along with commodities, but the dollar rose, gaining 1.7 percent against the euro for the week, to a level of $1.4139.

Buyers also bid up Treasurys in a flight-to-safety trade, pushing yields lower on the 10-year to 3.597 percent and the 2-year to 0.813 percent, levels last seen Dec. 18. Click here for bond quotes.

Stocks Correcting?

"In the near term, we have some things going on here that could cause a correction," said investment strategist Richard Bernstein, CEO of Richard Bernstein Capital Management. "As we move out in 2010, I'm more reasonably bullish, and I think earnings growth could be better than people think."

"Whatever the correction is, 5, 10 percent, I would be a buyer on that correction. I just think it will be a bumpy ride, but you'll do pretty well this year. The surprise is the U.S. is going to do reasonably well relative to the rest of the world," he said. Bernstein said the rising dollar though is a risk to the rally since as it rises, commodities prices decline, taking the market leader, materials stocks, lower. Materials shares were the worst performers of the week, down 6.4 percent.

Stocks in the past week rode a roller coaster of emotion and fear. First, the market gained on expectations that Republican Scott Brown would win the Senate race in Massachusetts, shifting the balance of power in the Senate from a Democratic 60-seat stronghold. The Wall Street hope was that his election would create gridlock in Washington and prevent some Democratic referendums, like health care reform, from succeeding. He did win, but markets were overtaken by worries out of China that it is curbing bank lending in a bid to slow its economic growth, (and therefore the growth of the world economy). Click here for the latest business news from Asia.

Brown's victory was also seen as a backlash by voters toward the Obama Administration's policies and deficit spending. A new sense that Washington could pull in the purse strings added to the gains in the dollar.

Bernanke Under Fire

By Thursday though, the focus quickly shifted to the financial industry when President Obama declared reform measures that would limit the ability of major banks to participate in certain risky businesses. That news drove the shares of major banks and the stock market lower on Thursday, and by Friday, the tenure of the Fed chairman took center stage as some prominent Democrats said they would not endorse him for a second term.

Two Democratic senators facing re-election—Barbara Boxer of California and Russ Feingold of Wisconsin—were among those announcing their opposition to Bernanke.

Sen. Harry Reid, the Democratic majority leader, late Friday announced his support for Bernanke and said he would schedule a vote late in the coming week. In all likelihood, Fed Vice Chairman Donald Kohn would step in to temporarily cover for Bernanke if he is not reappointed by the end of his term Jan. 31.

"If it's just a delay action, a signaling process, the impact won't last long," said Pimco senior strategist Tony Crescenzi. "If its because there's growing opposition behind the scenes, the markets might get more nervous."

"This would be happening in the context of a couple of weeks of news that 's affecting investor psyche. In the context of that, it would harm confidence with respect to U.S. assets," Crescenzi said.

Crescenzi said it would be a bad signal to markets if Bernanke is not reappointed. "There's a broader signal that would come with respect to government involvement ... that would be illuminated," he said. The focus in markets is heavily on sovereign debt risk. "The U.S. is such a large debtor. This would be a risky gambit by the Congress to consider such an action," he said.

"In the context of all that's happened it would be viewed as a negative. Ultimately in the long run, what would matter is that the U.S. gets its fiscal house in order because that's what's needed to preserve the value of the dollar. The question is whether these actions taken in Washington might be an overreach and harmful in the long term to the U.S. economy and the financial system," he said.

"I think it's significant. I would probably have been dismissive of the risk of Bernanke not being Fed Chairman until today," said Foreign Exchange Analytics strategist David Gilmore in an interview Friday. "With the way the Democrats are lining up, it looks like he could easily be short of votes. I think that's significant and it's a short term negative for the dollar, but I think there's a bigger story lining up."

No More Easy Money

End to Easy Money

Gilmore said an early sign of the next big thing for markets has already been seen with the Chinese move to tighten lending. He also noted the Fed this week is expected to reemphasize that it is soon ending its programs to buy mortgages. More such moves to end monetary stimulus are on the horizon while the economy is not yet showing signs that it is really gaining traction in the private sector, he said.

"I think we get past the sort of Bernanke confirmation uncertainty, then I think we're going to go back to the dollar streaming higher on a big risk aversion trade," he said.

Bernstein, meanwhile, said he opposes Bernanke's reappointment—and the Fed's prolonged low interest rate policy. "I'm not a Bernanke fan. One of my arguments is we've done nothing to correct the structural issues with the economy. Mr. Bernanke is going to be reappointed and continue Greenspan/Bernanke monetary policy, which clearly has not worked. Wall Street loves it because they provided free money," he said.

The strategist also said Obama did not go far enough in reining in banks. Obama's rules would prohibit banks from investing in their own hedge funds and private equity, as well as reduce proprietary trading. "We know in the United States that we need the savings rate to go up...It's a secular change in the United States that we need to foster. Everything we need to do in the financial system is to make sure savers are safe and secure. Making sure that top traders or banks can lever Wall Street profits from trading has to take a back seat to the safety and security of deposits," he said.

Bernstein said he would favor reinstating rules that separate investment banking businesses from commercial banking. "It is not in the best interest of the financial sector, and it may not be in the best interest of my own business, but it is in the best interest of the whole country to make sure depositors are the number one priority right now because we need our savings rate to go up," he said.

Gilmore said Obama's State of the Union address Wednesday night could be a factor for markets. "I think this has more importance than others I recall because there's so much on the line right now, and it's all politics. What's going to happen to health care? That's a big part of the stock market. What's going to happen to regulatory reform? That's a part of the stock market. The dollar's going to trade on that," he said.

Winterizing Your Portfolio - A CNBC Special Report
Winterizing Your Portfolio - A CNBC Special Report

"If markets think Wall Street is at war with Washington, it won't be pretty. That might be the message that comes out in the State of the Union...the question the White house has to ask before the State of the Union is how much do you want to push this because if they push too far, it will affect asset prices, namely stocks, and that's one element of the current financial picture that is positive," he said.

What to Watch

Treasury Secretary Tim Geithner finds himself in the hot seat Wednesday when he testifies before a House panel investigating the New York Fed's handling of AIG's disclosures about its rescue. Geithner, New York Fed president at the time, has said he was not involved in a decision to have AIG withhold information.

The two-day Fed meeting, the final one in Bernanke's term, should end with relatively little change to the Fed statement. Crescenzi said the Fed is likely to leave in tact the commitment to keep rates low for an "extended time" and reaffirm that it will end its mortgage buying program. He also said it should have little change to its economic forecast.

"The trajectory hasn't steepened on the (economic) data that is moving upward. Employment seemed to be getting better. Then there was a not so good December employment report. Jobless claims four week moving average ticked up a bit," he said. He said the economic recovery has not yet become self-reinforcing.

The big data to watch this week includes fourth quarter GDP on Friday. Crescenzi said GDP is expected at 4.5 percent but he expects slower growth in 2010.

There is also housing data with existing home sales Monday; home price data Tuesday and new home sales Wednesday. Consumer confidence is reported Tuesday and consumer sentiment, Friday. On Thursday, weekly jobless claims and durable goods are reported. On Friday the Chicago purchasing managers and the employment cost index are released.

There is also $118 billion of 2-, 5- and 7-year notes being auctioned by Treasury Tuesday, Wednesday and Thursday. "With the stock market (sell off) and U.K. terror alert, there was a flight to quality, to safe money (Friday) ... nobody wants to be short Treasurys despite the fact you have supply next week," said Jefferies Treasury strategist John Spinello.

The U.K. raised its terror alert to "severe" during late trading Friday. U.S. officials said the U.K. move was in response to the non-descript threats of Al Qaeda attacks that had U.S. officials heighten airport security the week earlier.

Spinello said traders were seeking the safety of Treasurys before stock markets open in Asia Sunday. "They're afraid stocks in Asia will trade substantially lower. Nobody wants to be short Treasurys over the weekend," he said. Spinello said he thinks stocks will open lower Monday but rebound later in the week.

Earnings Central

The backdrop to all the action in Washington in the coming week will be a steady stream of corporate earnings reports. Apple, which reports earnings Monday, is also expected to unveil its tablet computer later in the week.

Amgen and Texas Instruments report earnings after the bell Monday. Johnson & Johnson , DuPont , Travelers , Verizon , Yahoo, U.S. Steel, EMC, Corning and Delta report Tuesday.

Wednesday's reports include Boeing , Caterpillar , WellPoint, United Technologies , General Dynamics, Abbott Labs and BlackRock. After-the-bell reports that day are expected from E*Trade, Netflix, Norfolk Southern and Qualcomm.

3M , Procter & Gamble , Bristol Myers, Eli Lilly, Ford, Nokia, Altria, Colgate-Palmolive, Eastman Kodak, Raytheon, Time Warner Cable, LockheedMartin, Motorola and Occidental Petroleum are among the companies reporting Thursday morning. Microsoft , Amazon.com and KLA-Tencor report after the bell that day.

Chevron , Fortune Brands, Honeywell, and Mattel report Friday.

Questions? Comments? Email us at 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.

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  • 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.

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