Sovereign debt dramas in the U.S. and Europe and a raft of corporate earnings news promise to make for a volatile week for markets.
Washington's political grandstanding around the deficit reduction and debt ceiling discussions have given already nervous markets another reason to be on edge. The consensus, however, still believes that the debt ceiling will be raised and some lesser agreement on spending cuts will be reached.
By Thursday, European leaders will be meeting on Greece and will try to resolve differences over how to involve the private sector in its bailout, the last hurdle ahead of another round of funding.
Economic reports in the coming week include home sales and jobless claims in the U.S. and PMI manufacturing data from China Thursday. More than 20 percent of the companies in the S&P 500 index report earnings, including American Express, GE , Bank of America, McDonald's, IBM, Apple, and Intel.
"In a perfect world, you'd actually say the earnings should be the thing you'd be concentrating on, and we would still say that's the thing you should concentrate on as a long term investor. But you could make a good assumption that even good earnings could be trumped by something coming from Europe or the debt ceiling issues," said Bill Stone, PNC Asset Management chief investment strategist.
Stone sees margin levels this earnings season holding flat in the second quarter, at around 8.6 percent, excluding financials and utilities. He notes that since second quarter margins are historically higher than first quarter, there could be some slight upside surprises to the margins. He also expects the dollar to provide a tailwind to earnings, as about one third of profits are derived from international markets.
"The more cyclical areas are more likely to show the better numbers — materials, industrials. They're still living off some of those higher commodities prices," said Stone. "The financials will be the wild card." So far, the few major earnings reports have been better-than-expected, including JPMorgan, Citigroup and Google.
"I guess you could say to yourself, barring the macro events intruding on us, that earnings will help (stocks), but I have to put a caveat on it. To me, everything goes back to the persistent cause for the weakness, and that is worries about the economy," said Stone.
Stocks in the past week were sharply lower, after being pelted by headlines from Europe and the threat from ratings agency of a downgrade for the U.S. AAA credit rating. Stocks also took a hit when Fed Chairman Ben Bernanke, in the second of two days of Congressional testimony Thursday, clarified his earlier comments, assuring markets the Fed does not have plans for another round of easing.
The Dow was down 1.4 percent to 12,479 for the past week, and the S&P 500was down 2 percent at 1316. The Nasdaq fell 2.5 percent to 2789. The VIX, the Chicago Board of Options Exchange's volatility index, gained more than 25 percent on the week. It was at 21.68 Friday.
"We've seen a lot of out-of-the-money put buying. We also had an expiration... That always gives you a little extra volatility, and there's also just weirdness," said Patrick Kernan, who trades S&P 500 options at the CBOE.
"We've seen the puts skew go up quite a lot over the last few days, and a lot of that is people buying a lot of little puts, just as protection, just in case Congress can't get the debt ceiling straightened out or something happens in Europe," said Kernan, who is with Cardinal Capital. He said the VIX is implying the potential for steep 1.25 percent swings in the S&P, in either direction.
The dollar bounced higher against the euro in the past week, gaining 0.8 percent. The euro was at 1.4157 on Friday. Concern about Italy, which adopted an austerity package Friday was among the big issues of the past week. But credit default swapsof the entire periphery moved higher and were elevated Friday.
Stress test results for 91 European banks were released Friday, with just eight failing. There were five Spanish savings banks, two Greek banks and one Austrian bank that failed. A ninth German bank would have failed as well, but it dropped out of the process.
"The tone next week is going to initially be set by how we digest the bank stress tests... A lot of bank analysts are going to spend the weekend going through the data," said Alan Ruskin, global head of G-10 foreign exchange strategy at Deutsche Bank. "I think that'll set us up for the first day or two of next week. The Greek story is percolating under the radar. They are still waiting for news on what kind of private sector involvement is envisaged — whether banks will be heavily involved or penalized on the basis of the kind of plan that's going to to be forthcoming to provide more funds for Greece. It seems an awful lot of details need to be worked out before we march into the prime summer holiday time."
Ruskin said the markets may react more to the European headlines than U.S. headlines initially in the coming week, and will be watching how Italian and Spanish bonds trade.
"It seems like the rating agencies are setting the benchmark quite high for what they (Congress) need to do to avoid a rating downgrade" for the U.S.," he said. "I would not want to miscalculate that a debt downgrade is not a major event. You might find the initial reaction is quite modest, but it would create uncertainty and noise, and absolutely undermine confidence in policy making in this country. That in itself is a big negative. The fact that political process is blocking solutions, that is negative for the currency," he said.
Brian Dolan of Forex.com said he sees the euro remaining under pressure in the coming week and expects risk markets to remain choppy. "The only thing preventing a collapse in the euro right now is the dollar is also out of favor. And once we get some resolution from Washington, the dollar should see a pretty decent rebound and that could open the gates for some downside in the euro," he said.
Treasury Secretary Tim Geithner should again make a case for raising the debt ceiling when he appears Monday at 8 a.m. on "Squawk Box." Talks in Washington could continue over the weekend, in an effort to break a seeming impasse between the Democrats' demand for tax increases and the Republican demand for bigger spending cuts.
Treasurys prices moved higher in the past week, with the 10-year yield inversely moving lower to 2.906 by week end. "The market is grasping at very thin straws at a time when we should all recognize that there's just too much event risk that we face... in the next couple of weeks. ... so you can't have strong directional views," said David Ader, chief Treasury strategist at CRT Capital.
"I still think we could see 3.25 percent 10-year note, assuming the debt ceiling gets done. The economic side still looks fragile and they're going to to cut spending," he said, noting the reduction in government spending would remove a stimulus from the economy.
Ader, like others in the bond market, said the bond market would not necessarily react poorly if the U.S. did default by failing to meet the Aug. 2 deadline to raise the borrowing limit. "If we defaulted and we had people not getting Social Security, confidence would plunge. Bonds would sell off initially. Stocks would do worse, and everything else would do worse, and in the bond market, we'd realize we shot ourselves in the economic foot," he said.
But as risk assets then collapsed, bonds could return to favor with the view the U.S. would honor its debt. "The initial response is going to see Treasury get pummeled, and then the next respond will be, buy Treasurys," he said.
Housing data is prominent in the week ahead. The National Association of Home Builders survey is Monday, and housing starts are reported Tuesday. Existing home sales are released Wednesday, and the FHFA home price index is out on Thursday. On Monday, Treasury releases data on international capital flows. Thursday's data includes weekly jobless claims, the Philadelphia Fed survey and leading indicators.
On the corporate front, major financial, tech, drug, airline, industrial and consumer companies report in the week ahead. There will also be developments in the News Corp phone hacking saga, as Chairman Rupert Murdoch and his son, deputy COO James Murdoch, testify before Parliament Tuesday on the British tabloid scandal that has shaken the company. On Friday, Dow Jones CEO Les Hinton resigned, as did U.K. newspaper CEO Rebekah Brooks.
Monday's earnings reports include IBM, Halliburton, Charles Schwab, and Mosaic. On Tuesday morning, Bank of America, Coca-Cola, Goldman Sachs, Wells Fargo, Johnson and Johnson, Bank of NY Mellon and Novartis report.
Apple, CSX, Chipotle, Stryker, VMWare and Yahoo report after Tuesday's bell. AMR, Blackrock, EMC, United Technologies and Abbott Labs report Wednesday morning, and American Express, Intel, eBay and F5 Networks report after Wednesday's bell.
Thursday's morning reports include AT&T, Morgan Stanley, Nokia, PepsiCo, Travelers, United Continental, Blackstone and Roche. Microsoft, AMD and International Game Technology report after the bell Thursday.
GE, Caterpillar, McDonald's, Honeywell, Verizon and Xerox report Friday.
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