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Week Ahead: Markets Will Be Hyperfocused on Economy After Dreadful Jobs Report

As the second quarter earnings season begins, the focus will be on what more can corporate America tell the markets about the state of the economy.

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A handful of big earnings reports are on the calendar in the coming week, starting Monday with Alcoa, and including JPMorgan, Google and Citigroup. But stock market investors may be even more focused on the reports expected on retail sales, jobless claims and inflation as they attempt to piece together a picture of the economy after Friday's shockingly poor June jobs report.

"This earnings season is going to be trumped because who is going to care about what Alcoa did a quarter ago when the weekly unemployment claims are determining what the second half is going to be. The market is going to be concerned about claims, retail sales and ISM. They're not going to be concerned so much about what somebody made last quarter. They're going to be looking out the front window, not the rearview mirror," said James Paulsen, chief investment strategist at Wells Capital Management.

"I think the company commentary could take on even more significance than it usually does. They're going to be commenting on what they think things are going to be feeling like for the second half. That's going to be more important than what they did for the second quarter, I think," he said.

The markets will also be dealing with other cross currents, from the deficit and debt ceiling talks in Washington, to worries about European sovereign debt, now that Italy seems like it could be a problem. European officials also release the result of stress tests Friday on 91 financial institutions and what remedies they may need to take.

Fed Chairman Ben Bernanke makes his semiannual appearance before Congress Wednesday and Thursday, as markets digest the first series of Treasury auctions since the Fed ended its $600 billion QE2 Treasury purchase program.

Earnings are expected to be strong for the quarter, but analysts do note the potential for surprises, given the lack of corporate guidance or warnings ahead of this earnings season. The estimate for earnings growth for the S&P 500 is 12.7 percent for the quarter, or 13.8 percent without Bank of America, according to Factset. (Bank of America is taking a big nonrecurring charge for its 8.5 billion mortgage settlement).

Goldman Sachs, in a note Friday, said it expects positive surprises in consumer staples, which were able to raise prices to offset rising commodity costs. The Goldman analysts expect the financials to contain negative surprises, even though earnings estimates have been revised down by 24 percent for the group in the past two months.

"I watch GDP revisions during the quarter. When they get revised up, generally you get an outperforming (earnings) quarter. They're going the other way. That tells me there's risk. Let's face it, we know we're in a soft patch," said Paulsen. Economists expect about a 2 percent growth rate in the second quarter, while many had been above 3 percent or more earlier in the year.

Whither Stocks

Stocks in the past week scored gains, even with a downdraft on Friday after the government's monthly employment report revealed that just 18,000 jobs were createdin June. The market stabilized however, and the Dow was down just 62 points after registering triple digit losses. For the week, the Dow was up 0.6 percent to 12,657; the S&P 500was up 0.3 percent at 1343, and the Nasdaq was up 1.6 percent at 2859, as the technology sector outperformed with a 1.6 percent gain fro the week.

Analysts have been divided over the upcoming earnings season and its potential impact on stocks, but Dahlman Rose chief portfolio strategist Brian Rauscher says it may be a good time for the market.

He said his tactical market model flashed a buy signal a week ago Thursday, and based on past signals, it suggests a rally of 10 to 16 weeks in duration that could be as strong as 13 to 17 percent. He said, however, his other strategic model does not confirm the call and suggests it would be better to stay in defensive stock groups. The rally could be even stronger and longer were both models to confirm it, he said.

"My tactical model for the first time since last September flashed 'buy'," he said. "I've only had six such buy signals since 2006." Others were in February, 2010 and February 2009, just before stocks took off in March, 2009. His model is based on earnings revisions, valuation and price momentum.

Rauscher said when he looks at the momentum of earnings revisions, companies in the defensive sectors are continuing to revise estimates upward, but the offensive sectors are slowing down positive revisions. "What we like to see is when we have the highest of high conditions, and we see very big rallies or big pullbacks, is when the earnings and valuation are confirmed by the price momentum. When the price momentum is giving a contrary signal to the earnings and momentum, it usually wins out," he said. "Sometimes things don't perfectly confirm, like now, and we have a mix."

"When it's done in my opinion, I'm going to be expecting a top of some significance," he said.

What to Watch

Bernanke is in the hot seat on the economy Wednesday and Thursday as he appears before the House Committee on Financial Services and the Senate Committee on Banking, Housing and Urban Affairs.

Already with one bad jobs report, talk on the street turned to whether the Fed may have to do another Treasury purchase program, or quantitative easing. Fed watchers note it is unlikely as yet, but Bernanke will be watched very closely to see if he continues to discuss the economic slowdown as temporary or something more worrisome.

"I think he'll probably stick to the main points he made a few weeks ago, but maybe a little more cautious about the rebound story. I think he hedged himself pretty well last time," said J.P. Morgan economist Michael Feroli.

Feroli said he is not yet ready to change his growth forecast for the third quarter, after the weak jobs report. "We haven't revised anything per se, but the risks are now tilting to the downside for the third quarter. We are in the process of assessing and thinking about it so we haven't made any judgment yet, but I think it's clear that you've lost some momentum," he said.

The second weak jobs report in a row also prompted speculation about the possibility of a double dip recession. Economists for the most part have been expecting stronger second-half growth and blame the first half slowdown on Japan's supply chain disruption; higher energy and commodity prices and weather disasters.

"It's too soon" to discuss a double dip, according to Nomura Americas Treasury strategist George Goncalves. "Data's rolling over again like it did last year. The only thing we haven't seen is deflationary fears coming into the market. If inventory keeps building up and nobody's buying, the people will start slashing prices."

Goncalves said the debt ceiling discussions are a key event for markets this week, as Congressional talks towards a compromise on deficit reduction and taxes continue over the weekend. The U.S. will exceed its debt limit Aug. 2 if the debt ceiling is not raised by Congress. "The deficit/debt ceiling discussion is critical. It could come off as a sign of strength if there is a resolution, and we show we're getting our fiscal house in order and the ability to reach compromise...that would be good for all assets, definitely stocks and the bond markets. It would be a vote of confidence on U.S. assets," he said.

"On the flip side, you have this other sovereign place — Europe — that can't get its house in order. Look at the Italian banks. Look at the Italian yield curve. Look at the CDS curve starting to invert and also look at the German versus Italian rates. We've had the biggest move this week, more than in 2010. Last year, Italy wasn't even in the cross hairs," he said. Key events in Europe this week include a European finance ministers meeting Monday, where the Greek bailout will be discussed.

The U.S. Treasury will auction $66 billion in 3-year notes, and reopened 10-year notes and 30-year bonds Tuesday through Thursday. "This is very important for the bond market. It's the first time we're going to have auctions without the QE2 effect. They were sloppy last time when QE2 was coming to an end, and people were saying this is what's going to happen going forward. If it doesn't go well, it could be bad for every market," Goncalves said. "... I do think the auctions will be met with demand because of today's data (jobs) report." Treasury yields slipped, as investors bought bonds in a safety play Friday. The 10-year was yielding 3.021 percent.

Econorama

On the data front, retail sales is the highlight of the week Thursday morning. "If that holds, I think it's a good sign," said Feroli. He expects a decline of 0.2 percent, but a gain 0.4, excluding automobile and gasoline sales.

Three is also the NFIB small business survey and international trade figures Tuesday. On Wednesday, there are import prices and the minutes of the last Fed meeting. Thursday's reports include weekly jobless claims; producer price inflation data and business inventories. CPI is reported Friday, as is the Empire State survey; industrial production and consumer sentiment.

Earnings reports include Alcoa's second quarter release and Chevron's interim report Monday. Tuesday's reports include Fastenal and Infosys . Marriott and Yum Brands report Wednesday, and JPMorgan and Google report Thursday. Citigroup and Mattel release results 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.

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