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Week Ahead: Stocks In Tug of War Between Good Earnings, Bad Economic Reports

Sunday, 18 Jul 2010 | 10:25 AM ET

The stock market is fixating on crumbling confidence in the U.S. economic recovery and may continue to ignore the good news that's likely to show up in corporate earnings reports in the coming week.

Stocks fell about a percent in the past week, but a torrent of selling Friday drove the S&P 500 down nearly 3 percent to 1064 and the Dow down 2.5 percent to 10,097. The dollar came under fire, losing 2.2 percent on the week against both the yen and euro, as a string of disappointing U.S. economic reports shifted the focus from Europe's problems, to the question of whether the U.S. economy will see a double dip recession.

Outside the New York Stock Exchange in lower Manhattan.
Photo: Oliver Quillia for CNBC.com
Outside the New York Stock Exchange in lower Manhattan.

In the coming week, a dozen of the Dow 30 stocks and about a quarter of the S&P 500 will report, including Apple, Goldman Sachs, Coca-Cola, IBM, McDonald's and Caterpillar. There are a small number of economic reports, and most of them focus on housing, a trouble spot for the economy.

Fed Chairman Ben Bernanke testifies on the economic outlook before Congressional committees Wednesday and Thursday, and by the end of the week, the focus will be back on Europe. Friday is the day that the results of stress tests on 91 European banks are scheduled to be revealed.

Investors are also focused on BP's latest efforts to stop the flow of oil from its broken well in the Gulf of Mexico. The well cap seemed to be succeeding at the time of the market close Friday.

Whither Stocks?

Stocks climbed into the start of the second quarter earnings period, and a number of strategists had predicted a brief period of gains on earnings news before the market would once more stumble on worries about the economy, taxes and other matters. But now there is concern that those earnings gains may have been short-lived.

"My view is we are in a growth slowdown phase and we're going to live with it for awhile. I think second quarter earnings will help, but I think corporates, because they are scared of the same things you and I are afraid of, are afraid to give much in the way of guidance," said BlackRock vice chairman Robert Doll in a telephone interview.

"The good news is we slowed down to a slower rate of growth, not a double dip in my view. I think we will stay bumpy because of all the cross currents.. At some point, valuations also matter, and stocks are pretty cheap," Doll said.

In a note, Goldman Sachs stock strategists pointed to the worrying trend of individual stocks not responding to their own positive earnings reports.

"Arguably the S&P 500’s recent 7 percent rise heading into earnings season largely discounted much of the earnings upside. But it is not a positive sign when firms such as the Industrial firm W.W. Grainger post strong results with June US organic sales up 12 percent year/year and July tracking in-line with June so far and the shares close essentially flat on the week," they wrote.

Intel , which reported strong results and a strong forecast, saw the same effect.

Patrick Kernan, who trades S&P 500 options at the CBOE, said even with the big stock market decline Friday, there was a lack of panic in the market. "The VIX (the CBOE Volatility Index) was up 4 percent. Based on how we model, it should have been up 13 percent. What that means is that people weren't so nervous and there were people willing to sell options into the sell off, which I would say is more of a stable sign," he said.

Jefferies managing director Art Hogan said earnings may in fact help stocks in the coming week. "We had 23 reports, 20 upside surprises," he said. "So where did we start the month of July? 1019 (on the S&P)..Is the sky really falling? I think we're in pretty good shape. It's a tug of war between a soft patch in the economic data stream and strong corporate earnings," he said.

Doll said he has become more pro-cyclical since the stock market started correcting from its April highs. "Into the teeth of the decline, as the market went down in its 15 percent correction, a lot of cyclicals were down 30 to 40 percent," he said. Doll said he added to global cyclicals by trimming some holdings in health care, telecom and staples.

"My gut is we're in a range-bound market but with reasonable probability that we have seen the lows. We might have to test it again but I think we're in a bottoming phase," he said.

"I think the dire forecasts are only going to come true if we double dip, and I don't think we're going to have a double dip," he said.

Finally, JPMorgan Chase late on Friday cut its forecast for this year's U.S. economic GDP growth by a full point, to 2.6 percent.

Extraordinary Moves by Fed?

Econorama

The past week's weaker retail sales and manufacturing data were among the latest disappointments, and economists continue to pare back their growth forecasts for second quarter and second half GDP. The Fed itself revised its forecast in the past week for GDP this year of 3 to 3.5 percent, from 3.2 to 3.7 percent.

Friday's report of a near 10-point decline in consumer sentiment, to an 11-month low of 66.5, led to the sharp market sell off.

"The data's definitely been soft lately. Consumer spending data has been on the softer side. Manufacturing data, definitely. They're not unhealthy, but they're pointing to a deceleration in the growth rate. I think it's indicative of the level of cautiousness that's developed over the last month. That's certainly been in the news of late. My view is it's with us for a while, but it's not going to be a long-term thing," said Stephen Stanley, chief economist at Pierpont Securities. He said he has downgraded his GDP forecast to show growth of close to 3 percent for the rest of the year, down from a previous expectation of near 4 percent.

Stanley said Bernanke's comments this week will be watched closely for any indication of further extraordinary moves by the Fed. The Fed's minutes this past week indicated it would take whatever other steps are necessary if the economy becomes too weak.

Traders immediately started speculating the Fed may embark on a new asset purchase program. "There's certainly been a lot of chatter about the Fed doing more asset purchases, and if it's moving in that direction, I see that as a tail risk possibly," said Stanley. "They're doing their contingency planning but the odds are low" of a new program.

"I've not been particularly excited by the magnitude of the benefit they got out of the asset purchases," he said.

In the past week, the long end of the Treasury market steepened while spreads on short to intermediate term notes remained flat, amid choppy economic news. The NOB (notes over bonds) widened to a near record level of more than 100 bps intraday on Friday. The 2-year in the past week, reached record low yields and finished Friday at 0.585 percent.

"They've got the markets excited. The 2-year is down to 60 bps. I think Bernanke's testimony comes at an interesting time because of that. He's in a tough pickle. I don't think he wants to do anything that moves the market significantly. How he finesses his way out of this is the question," he said.

Besides Bernanke's two days of semiannual testimony before House and Senate committees, investors will be watching a few economic reports, mostly housing related. On Monday, the National Association of Home Builders survey is released. Housing starts are reported Tuesday, and existing home sales are released Thursday. FHFA home price data is also reported Thursday. Weekly jobless claims are due Thursday, as are leading economic indicators.

What We'll Learn from Europe Bank Tests

Stressed Out?

Markets have been waiting for the outcome of European bank stress tests, and many economists and analysts expect the results to be anti-climactic, much like the U.S. bank stress tests.

"I think it has the potential to be a big relief. If you think back to last year, when the U.S. stress tests were conducted ..There were a lot of rumors about who is going to fail and who was going to pass and all the rest. Then when it came out, it was: 'that's behind us. Now we can move on,'" Stanley said.

"My guess is somebody's going to need capital ... and I think it will look like the U.S. ... For the most part, the banks that need capital will be able to get it. If it's the big guys, they'll be able to do what was done in the U.S., and they'll be able to go to market." He said smaller, more poorly capitalized banks will need government help.

Robert Sinche, chief strategist with Lily Pond Capital, has a different view, and he thinks the euro's recent rise may be cut short, once the results are out.

"There is a risk of buy the rumor and sell the fact on the euro here, that the market's got too complacent about what kind of healing this will bring about. It's not going to fix the sovereign debt problem. It's not clear it's even going to measure the sovereign debt problem," he said.

Sinche said unlike U.S. banks, European banks don't have much latitude in marking down their troubled assets because it is sovereign debt of EU members. "Banks aren't going to come out and say, 'sovereigns need to be restructured and their hair cut would be 'X.'"

"Most of the bonds are held in the 'hold to maturity' book.. I think there will be a legitimate criticism from the skeptics to say they didn't assume a real restructuring of sovereign debt in Europe," he said.

"What they'll say is if we assume spreads widened out to 'X,' this would be the mark to market impact," he said. "This would be in their 'trade for sale' and not in their hold to maturity books." That in itself reduces the universe of assets being examined.

Earnings Central

IBM Sign
Aaron Brown: Photography
IBM Sign

More than 125 S&P 500 companies report earnings in the week ahead, including 11 of the 30 Dow stocks. Drug companies, financials, tech, industrials, transports and consumer companies report in one of the heaviest weeks of the quarterly earnings season.

Big tech IBM and Texas Instruments report Monday, as do Delta, Halliburton, Hasbro, Philips Electronics and Tupperware. Tuesday's reports include Goldman Sachs , Johnson and Johnson, PepsiCo, Biogen Idec, State Street, TD Ameritrade, UnitedHealth, Whirlpool, Peabody Energy and Illinois Tool. After the bell, Apple , Altera, Boston Scientific, Sallie Mae, Yahoo, Stryker, VMWare, Juniper Networks and Seagate Tech report.

Wednesday's releases include Coca-Cola, United Technologies, Wells Fargo, Abbott Labs, Altria, BlackRock, Eaton, US Bancorp, Manpower, Northern Trust, Genzyme and Quest Diagnostics. After the bell reports include eBay, Starbucks, Netflix, Western Digital and Xilinx.

AT&T , Bristol-Myers Squibb, Caterpillar , 3M, Glaxo, Travelers, Lilly, Air Products, Blackstone, Continental Airlines, Medco, Hershey, Xerox, Nokia, PNC, KeyCorp, SunTrust, Union Pacific and UPS report Thursday morning. Amazon.com , American Express and Microsoft report after Thursday's closing bell, as do SanDisk, Capital One , E*Trade, NCR and Mosaic.

Friday's reports include Ford , McDonald's , Kimberly-Clark, Honeywell, Johnson Controls, Schlumberger and Ashland.

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Questions? Comments? Email us at marketinsider@cnbc.com

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