Oil prices will be the trigger for stocks in the week ahead.
The Fed meets Tuesday, but it is not expected to take any action on interest rates and the meeting is expected to be uneventful. As usual, traders will watch for nuances in the Fed's post-meeting statement. Earnings from a few big names, like AIG and Procter & Gamble are expected, but otherwise there is a relatively quiet stream of economic data.
Oil, however, remains a top catalyst for stocks and a flare-up or big move down could set the trend for equities. Key for the energy market is how Iran responds to U.N. demands to end its nuclear program.
Volatility promises to be the daily theme, as the debate continues over whether the market is forming a bottom or ready to retest the July lows.
Stocks Troubled for Now
"We find it difficult to believe there is a sustainable upside for this market," said Abhijit Chakrabortti, Morgan Stanley's chief equities strategist.
Chakrabortti, in a phone interview, said he sees three key concerns: slowing growth outside the U.S., weakening corporate profits and inflation.
"We're far more negative on non-U.S. growth than on U.S. growth," he said.
He said he does not expect improvement in the earnings picture or the non-U.S. economies in the next six months, but that is not the case with inflation.
"Right now in our view is the next few readings will remain high because of energy and food prices, and the feed-through from that. This is the area we see abating most," he said.
But ultimately, this could become a good-news scenario for stocks, particularly into 2009. The slowdown in other parts of the world, like Brazil and India, will ultimately add strength to the dollar and should continue to bring down the price of commodities. This trend ultimately will be good for U.S. stocks, as a slowdown in inflation will reduce pressure on corporate profit margins.
But for now, the earnings scenario is worsening: "It's our view that profit margin deterioration is now underway," he said.
Chakrabortti said he believes a good level to be constructive on the market at is 1150 to 1200 on the S&P 500. He also believes that the market could still rally back to 1300 to 1350 by year-end, if his expectations for inflation and the dollar play out as he envisions.
Chakrabortti said some of his favorite stocks are in health care, which he says were very undervalued. He likes Schering-Plough , Abbott , Teva , Bristol-Myers and Amgen , as well as some of the big consumer staple companies, like Coca-Cola and Colgate-Palmolive . He also likes select financials including JP Morgan and Bank of New York .
(Morgan Stanley has or could have business relations with these companies, or own stock in them. Chakrabortti personally owns JP Morgan.)
"We are very bearish on materials and very bearish on the global industrial outlook," Chakrabortti said.
The Dow finished the past week at 11,326, with just a 44-point decline but that was after several days of violent moves up and down. The S&P 500 was up 2.55 or 0.2 percent to 1260. Crude oil rose $184 per barrel or 1.5 percent for the week to end at $125.10. The 10-year Treasury added 1-10/32 points, lowering its yield to 3.948 percent and the two-year was yielding 2.516 percent.
The Federal Reserve's one-day meeting Tuesday is the big economic event of the week. There is also a smattering of data throughout the week, with personal income and factory orders Monday, and ISM nonmanufacturing data Tuesday. On Thursday, weekly jobless claims are released along with pending home sales and consumer credit. Productivity and costs and wholesale trade are reported Friday.