It's bailout or bust for the markets in the coming week.
But as soon as Congress decides how to structure a rescue package, the big headache for investors will be the economy and the impact the credit crunch is having on an already weakened landscape.
There is a heavy calendar of economic data expected, including the important September employment report, due Friday. It is also the end of the third quarter, and analysts expect to hear preliminary comments from companies on their results, ahead of earnings reporting season in October.
"We've churned in the last month because of all this uncertainty out there. The bailout plan is only part of it," said Tobias Levkovich, Citigroup's U.S. equities strategist.
Levkovich said investors have been spooked by the the failures and concern about failures of financial institutions, among other issues. On Thursday, J.P. Morgan bought Washington Mutual deposits, branches and assets for $1.9 billion in an FDIC-brokered deal that wiped out shareholders.
On Friday night, newspapers reported that Wachovia was back in takeover talks, this time with major banks. It had been in merger talks with Morgan Stanley . Wachovia's stock had been down sharply in Friday's session.
The market has been struggling with each news development around Congress' consideration of the $700 billion bailout plan, proposed by Treasury Secretary Hank Paulson more than a week ago. Paulson proposed the government use the billions to purchase toxic debt from financial firms.
"The volumes have been lighter in the markets so clearly many investors have been sitting back and waiting. While we've had these big swings in the Dow, it's not really where a lot of investors have been focusing," he said.
He expects to see a lot of investor attention on earnings, especially as companies begin to warn in the coming week about the third quarter and future outlook.
"We have to get past this earnings uncertainty. This bailout issue won't be going on for weeks. That's not going to happen. There'll be an adjustment and we'll move on," he said. If the plan is not approved, "there'll be a plan B or plan C and we'll move on," said Levkovich.
Levkovich also believes there is uncertainty around the presidential election, and when that is over, there could be some relief buying, regardless of the outcome.
Levkovich currently has a target of 1475 on the S&P 500, but he is not optimistic the market will actually get there by year end. "It's asking a lot to run 250 points from here. I'm not ruling it out that it can't happen given the right circumstances. I just don't believe everything's going to right," he said.
JPMorgan U.S. equity strategist he thinks the stock market will focus on the bailout plan and then on liquidity. "Equity investors have responded to worsening liquidity conditions by raising cash balances," he wrote in a note. He said hedge funds have also been raising cash in anticipation of Sept. 30 redemptions.
The Dow fell 2.2 percent or 245 points to 11,143 this past week. The S&P 500 was down 31.71, or 3.3 percent at 1213.
Patrick Kernan, a principle with Cardinal Capital, said from the shape of things Friday, it looks like the market is set for another couple of weeks of high volatility. Kernan trades S&P 500 futures and he said a popular trade shows some big institutions expect the S&P to move about 80 points in either direction in the next couple of weeks.
The VIX, a measure of volatility, stood close to 36. "Twenty-five was a very big level for us. 30 was very high and 35...we're looking at levels we haven't seen since 9-11 for the most part. This is extremely high for us. We haven't seen sustained volatility like this where we're hovering at these levels since Long Term Capital," he said.
But it was the credit markets where some of the biggest action was. Spreads between Treasurys and all other types of credits were at record levels, after reaching a near panic level Wednesday and Thursday. Short-term T-bills were the investment of choice and investors watched rates fall to micro levels as buyers poured in. Two-year swap spreads shot up above 160 basis points during the week but were off highs at the end of the week.
The deep chill in credit markets has grown increasingly worse since the failure of Lehman Brothers , which continues to send ripples across markets. The focus now is on Washington and whether a bailout plan that works to fix frozen credit markets is possible.
Morgan Stanley Credit Strategist Greg Peters said the credit markets by the very end of the week were holding up a bit better than he thought they would given the historic moves. The markets "still have confidence something will be passed that's a workable solution and things will settle down, but nonetheless you are still seeing a lot of stress and strain in the lending markets at the short end. There's a long road ahead of us."
"The flow of credit has just completely stopped and so it takes some time to manifest itself vis a vis the (economic) data. What you're seeing is corporations are having extremely hard times rolling commercial paper. They are tapping bank lines so that is constraining the already constrained banking system. Banks are hoarding cash. They're not lending to each other," said Peters.
Peters said the credit situation is already making a weak economy worse. "This is a scenario we laid out in November—except on steroids. It's much worse than we thought. The flow through to the consumer and economy is worse than we thought...We just need a strategy to get out of it. Monetary policy in and of itself is ineffective. There has to be an alternative solution," he said.
The dollar fell 1 percent against the euro in the past week. Oil moved higher in the past week, gaining 4 percent to $106.89 per barrel. Gold gained 2.6 percent to $882.90 per troy ounce.
In the coming week, the September jobs report is particularly key but there is a heavy calendar of important data. On Monday, personal income is reported. Tuesday's data includes Chicano purchasing managers and consumer confidence. The widely followed S&P Case/Shiller home price index is also released that day.
On Wednesday, ADP's private sector employment report is released, as is ISM manufacturing data. Construction spending and the auto industry's monthly sales reports are also that day. On Thursday, weekly jobless claims and factory orders are reported.
The jobs report is released Friday and is expected to show a loss of 105,000 non-farm payrolls and an unchanged unemployment rate of 6.1 percent. ISM non manufacturing data is also released that day.
There are a few earnings reports in the coming week. Circuit City and Walgreen report Monday. Mosaic and Micron report Wednesday, while Marriott and Constellation Brands report Thursday.
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