Financial markets in the week ahead will again battle headwinds from Europe's sovereign debt crisis. Some of the more negative clouds over the U.S. economy appear to be lifting but here's what traders are worried about now — earnings.

AP

The lack of a clear path to resolution of the festering crisis in Europe has been driving up interest rates in the European periphery and pressuring shares of European banks for fear the ills of an ever weaker Greece will spread to other countries and the banking system. Rumors that Greece was close to default added to Friday's global equities selloff and is keeping markets on edge even though Greek officials denied the rumors and no payments are due for several weeks.

There is a flurry of U.S. economic data in the coming week, including retail sales on Wednesday and inflation data Wednesday and Thursday. In an encouraging sign, economists this past week began to raise third-quarter GDP forecasts. Goldman Sachs economists Friday raised Q3 to 2 percent from 1 percent based on better trade data and consumer spending.

Stock market traders will also be watching for an expected stream of warnings and commentary from corporate America, as companies react to how the global slowdown is impacting their third quarter earnings. That should also result in analysts trimming their expectations for third quarter and possibly beyond.

"I'm clearly warming up to the market," said Citigroup's chief U.S. equity strategist Tobias Levkovich. "But the thing that's held me up, the reason I'm not pounding the table is earnings expectations have to be cut. You're going to start to see that to some degree in the month of September."

Levkovich said he doesn't expect a return to recession and remains constructive on beaten down diversified financials and insurance stocks. He also is positive on tech hardware and semiconductors, which tried to rally despite the selloff Friday.

The strategist said he did not want to predict exactly when the market might turn around. "I think my gut feels it's by late September. I wouldn't want to try to pinpoint that," he said. On Friday, he adjusted sector recommendations, reducing energy to "market weight" from "overweight," raising telecommunications to "overweight" and transportation and household and personal products to "market weight" from "underweight."

Greek Drama

Europe will continue to dominate the headlines in the coming week. Brian Dolan of Forex.com said the EU parliament Wednesday debates the economy and debt crisis, and European finance ministers meet in Poland Friday but he is not looking for a major development.

European Central Bank executive board member Juergen Stark ruffled markets when he suddenly resigned Friday, leaving behind a newspaper opinion piece in which he said a "quantum leap" is needed in efforts to save the euro zone. Stark's resignation added to a deepening lack of confidence in the ability of a divided Europe to resolve its crisis.

"It's definitely markets twisting in the wind and doing their own thing," said Dolan. "Between 9/11 terror fears, Greek default rumors and Stark resigning, it looks like a little bit of an end-of-the-week throw-in-the-towel selloff, and we come in Monday and maybe see a few days of recovery." Sunday is the tenth anniversary of the Sept. 11 terror attacks, and New York City Thursday went into a heightened state of alert because of threats about car and truck bombs.

Dolan said it was technically important when the S&P 500 fell to 1148 Friday, but managed to close higher at 1154, above the key 1145-1150 support zone. The euro in the past week slumped nearly 4 percent to a near seven-month low of 1.3657, breaking below its 200-day moving average. The next level to watch is the 1.3620 to 1.3650, he said.

G7 finance ministers, meanwhile, were meeting in Marseilles, France, and said Friday that they are committed to a strong coordinated international response, and U.S. Treasury Secretary Tim Geithner said Europeans understand the gravity of their debt situation.

"What can the G7 do? There was some talk they could have coordinated rate moves but that doesn't seem to be very realistic. There was some talk there could have been coordinated intervention.," said Marc Chandler, chief currency strategist at Brown Brothers Harriman. "The G7 is more like a caucus for G20. Soothing words might fall flat as well. I think they (markets) want action. My sense is the markets want to see actions from policy makers. There's two theories. The European view is it's problems with excess debt and the solution is austerity. The U.S. point of view is that the problem is lack of growth."

The Greek economy, meanwhile, continues to fall apart, with recent GDP data showing the country heading into a deeper recession. The so-called "troika" of IMF, European Union and European Central Bank officials are expected to return to Greece in the coming week, but the country is proving unable to meet targets set as part of its bailout plan. Greek officials have said they will run out of money if they don't receive the next 8 billion euro tranche of funding in the next several weeks.

The countries of the euro zone are scheduled to vote over the next several weeks on an enhanced 400 billion euro EFSF (European Financial Stability Facility). "There's plenty of political intrigue around Europe on whether there's going to be government support for the bailouts ... there's plenty to watch," said Stephen Stanley, chief economist at Pierpont Securities.

"The Greek government is too big for the Greek economy. Unless they're going to have a permanent sustaining of the Greek government by Germany or someone, they're going to have to have an adjustment," said Stanley.

Chandler said the market is already pricing in the idea that investors will take a 50 percent haircut on Greek debt. "I think the real issue on Greece is between an orderly default and a disorderly default," he said.

Warming Up to Stocks

While the European debt crisis simmers, Citigroup's Levkovich said it may be time to give the market another look even with the problems in Europe. The Dow finished the week down 2.2 percent at 10,994, after a 301 point loss Friday, and the S&P 500 was at 1154, a decline of 2.6 percent.

Levkovich said there have been some signs that are encouraging him, including a measure he watches which shows investor behavior has become highly defensive, or in "panic" mode in his model. The last time it went into "panic" mode was for two weeks in June and prior to that, in the summer of 2010 when investors were concerned about a double-dip recession.

"It went into 'panic' mode two weeks ago. We are also where the valuation criteria has turned very positive for the market," he said.

Levkovich said the earnings revisions will be a positive for the market, removing some of the uncertainty. "I think we're going to have more warnings. We're getting them already... I think you'll get more next week when companies start to see flash numbers for the month and that will mark a turning point," he said.

"Things are lining up for why stocks should go higher. This is a trade, it's not a fundamental statement that everything is wonderful," he said. Levkovich said he is retaining his target of 1400 on the S&P for year end.

Econorama

Economic data in the coming week includes producer (PPI) and consumer (CPI) inflation data reported Wednesday and Thursday, respectively. Import prices and the small business NFIB survey are released Tuesday. Retail sales and business inventories are Wednesday. Weekly jobless claims, the Empire State survey, industrial production and the Philadelphia Fed survey are released Thursday. Consumer sentiment and the Treasury's' international capital flow data are released Friday.

The Treasury also auctions $66 billion in 3- and 10-year notes and 30-year bonds. The 10-year yield this past week was in record territory, at 1.92 percent late Friday after dipping to 1.89 percent earlier in the day.

Secretary Geithner and a group of major investors, including William Ackman of Pershing Square, Leon Cooperman of Omega and Blackrock's Larry Fink will appear Wednesday at a New York event, hosted by CNBC and Institutional Investor.

Fed Chairman Ben Bernanke speaks Thursday at a conference on the regulation of systemic risk in Washington. Fed Gov. Daniel Tarullo speaks at the same conference later that day.

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