Uncertainty surrounding Goldman Sachs will likely overshadow the positive news from dozens of major corporate earnings reports in the week ahead.
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Stocks tumbled Friday after the Securities and Exchange Commission announced fraud charges against the Wall Street firm.
The Dow lost 1.1 percent or 125 points, wiping out most of the week's gains. The Dow finished the week with a 0.2 percent gain, at 11,018, while the S&P was at 1192, down 0.2 percent for the week.
Some analysts say the Goldman fraud charges could be the event that will trigger a much anticipated stock market correction, and the magnitude of the decline will depend on how far the SEC investigation spreads and whether it also involves criminal charges.
The charges against Goldman, once the most revered (and envied) firm on Wall Street, come at a time when the idea of a sustainable economic recovery is taking hold. Investors have been less fearful, as economic news shows a more willing consumer and a surge in manufacturing activity. Corporate profits this quarter are showing improved top line growth, an indication the economy is getting better and a precursor to hiring.
Even against this back drop, many traders and analysts had been expecting the market to use earnings season as an excuse to reverse some of the gains made since it started going straight up in early February. In the past week, the Dow hit the 11,000 milestone and the S&P reached 1200, for the first time since September, 2008. The S&P is now 76 percent above its March, 2009 lows.
The SEC alleges that Goldman helped structure a complex financial product, tied to subprime mortgages, which favored one major client's short position, while hiding that fact from others. Goldman says the charges are unfounded. Paulson and Co, meanwhile, was the client that made a handy profit on the trade, while Goldman says it lost more than $90 million. Paulson was not charged by the SEC.
"It put back a wall of worry. That's a good thing from the point of view of continuing this rally. It's a refreshing pause," said James Paulsen, chief investment strategist at Wells Capital Management. "...I really think this (market) was stretched. You had a heck of a move in 45 days. You broke out of a range."
Paulsen said ultimately the shake out could be good news for stocks because it provides an opportunity for consolidation. Buyers also rushed into Treasurys Friday, pushing rates lower, another positive for a stock market that has been worried about yields creeping higher.
"It's a sizeable event and sizeable reaction, but I think ultimately people will respond to whether people are getting jobs or not ... ultimately investors should worry about initial jobless claims more than they worry about Goldman Sachs," said Richard Bernstein, chief executive officer of Richard Bernstein Capital Management.
The SEC's case against Goldman Sachs comes as Congress debates financial regulatory reform, and President Obama is making a major push to get legislation passed in the next couple of weeks. (See related story)
"Goldman does play into this financial regulation push in that it's likely to get more teeth in it and it's going to be hard to obstruct this one. We'll see who votes for it and who doesn't," said Brian Dolan of GFT Forex.
Dolan expects the dollar to move higher in the coming week, following the Goldman news, which he said was a catalyst for an expected reversal in risk assets. "Ultimately, we're looking at a pull back in risk. Why would gold come off? Why would oil come off on Goldman news? It's just hits high correlation and risk is off," he said.
"I think it's the beginning of the major restructuring of the financial sector that is desperately needed in the United States," said Bernstein. "In the last decade, the financial sector is too big a part of our economy. You can see it in the way a lot of lending in the last decade is intra financial sector lending. The mechanism for the transmission of capital between the financial sector and the real economy has broken down."
Bernstein said markets could be more seriously impacted if the Goldman case broadens or impacts the firm in a serious way, and that's what investors feared on Friday. "You have to figure their prime brokerage activity would have a meaningful impact on a lot speculative activities in the market place," said Bernstein.
Oppenheimer analyst Chris Kotowski, in a note, said he downgraded Goldman because it appears the SEC is pursuing an agenda aimed specifically at the firm. He said if other firms on Wall Street were also charged it would be better for Goldman because it would increase the chances that they would all be fined and responsible individuals would be punished.
What to Watch
About 20 percent of the S&P 500 report earnings in the week ahead, including major banks, tech companies and pharmaceutical companies. Major names reporting include IBMand Citigroup Monday: Goldman Sachs and Apple Tuesday; Boeing and McDonald's Wednesday; Microsoft and American Express Thursday, and Travelers and Honeywell Friday.
There are just a few pieces of important data in the week ahead, including existing home sales and weekly jobless claims Thursday and durable goods Friday. PPI is also reported Thursday, and leading indicators are released Monday.
Fed Chairman Ben Bernanke testifies on Lehman Brothers before the House Financial Services Committee Tuesday.
Dolan said the foreign exchange market will be watching IMF and EU meetings in Greece early in the week, as well as European sentiment indicators. Investor confidence is released for Germany and the euro zone Tuesday and the German IFO business confidence data is released Friday.
Another factor could be China, which this past week announced stricter rules on mortgages and indicated that it intends to allow its currency to appreciate.
Earnings Central
Other earnings include Halliburton, Lilly, and Hasbro on Monday. On Tuesday, Coca-Cola, Johnson and Johnson,Coach,Delta Airlines,Northern Trust and Yahoo report. AT&T, Morgan Stanley, United Technologies,Wells Fargo,eBay and Starbucks report Wednesday. Verizon,Nokia,Pepsi, Kimberly-Clark,Marriott, New York Times and Blackstone Group are among Thursday's reports. T. Rowe Price, Xerox and Schlumberger report on Friday.
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