U.S. Stocks Hope To Cement Nascent Recovery

NEW YORK (MarketWatch) -- Investors will attempt to cement a nascent recovery in stocks next week, seeking help from earnings growth outside the battered financial sector and trying to gauge whether much lower interest rates will be enough to prevent the U.S. economy from sliding into recession.

With little significant economic data next week, the market will turn to a slew of speeches by Federal Reserve officials, hoping to gain more insight into the thinking of central bankers after the Fed slashed its key interest rate by 125 basis points, down to 3%, in just 10 days.

News of a surprising drop in January employment on Friday wasn't enough to derail enthusiasm over Microsoft Corp.'s nearly $45 billion bid for Yahoo Inc. , which might indicate that investors are ready to start putting a floor under a battered market.

"The stock market tends to be a forward-looking discount mechanism," said Owen Fitzpatrick, head of the U.S. equity group at Deutsche Bank. "And the market has so far done a fairly good job discounting a recession in some sectors, and not in some others."

Stocks suffered through the first month of the year, with the Dow Jones Industrial Average falling 4.6%, its worst percentage decline for a January since 2002, when it lost 4.3%.

The broad S&P 500 index , which is heavily weighed by financial stocks, dropped 6.3% for the month. The technology-laden Nasdaq Composite slid 9.9%, its worst January since 2002.

Fed effect

But the market has begun to show some signs of recovery since the Fed delivered an emergency rate cut on Jan. 22, one day after a global sell-off in equities as fears mounted about a U.S. recession and troubles at financial institutions.

After falling below 12,000 on Jan. 22, the Dow has since rallied 6.5%. Just over the past week, it gained 4.4% to settle at 12,743. The S&P has gained 6.5% over the past 10 days and is up 4.9% from a week ago to stand at 1,395. The Nasdaq is up 5.3% since the Fed's emergency cut and it gained 3.7% to 2,413 last week.

Still, the market remains far from its October highs, when the Dow was still towering above 14,000, and just as the impact of bad U.S. home loans developed into full-blown global credit crisis.

The sliding U.S. housing market, together with the credit crisis, have now led many in the market to believe a recession, or at least a sharp deceleration of economic growth, is already under way, a belief many thought was confirmed by the January drop in employment.

"We're not out of the woods yet," said Deutsche Bank's Fitzpatrick. "The Fed is helping by cutting rates, and that may help financial institutions, but not the pricing of mortgage-backed securities."

So-called subprime U.S. mortgage loans were packaged into such securities and sold to financial institutions across the world, until a tidal wave of defaults forced banks to start declaring losses, while no one knows for sure how much these might amount to globally.

"Hopefully, you get to a point where you get to write everything off, and the market has already discounted a good portion of the losses," Fitzpatrick said.

In the meantime, investors hope that the Fed will continue to cut interest rates to boost financial markets and the economy.

After the employment report Friday, the market is betting that the central bank will cut interest rates by another 50 basis points at its March 18 meeting.

Fed speakers, data on tap

The market will turn to "a flood of Fedspeak next week, now that the [Fed] meeting is out of the way and 225 basis points of monetary stimulus has been put into play since September, and over half of that in the past two weeks," analysts at Action Economics said in a note.

On Monday, Fed Gov. Randall Kroszner will speak, followed by Richmond Fed President Jeff Lacker on Tuesday and Wednesday. Philadelphia Fed President Charles Plosser will also speak Wedesday, followed on Thursday by Atlanta Fed President Dennis Lockhart, Dallas Fed President Richard Fisher and San Francisco Fed President Janet Yellen.

"It would be a surprise if this diverse collection of Fed members spoke with one voice on recent dramatic policy easings," Action Economics said.

As for economic data, investors will turn to December factory orders and the ISM's survey of the service sector of the economy on Monday, productivity and costs data on Wednesday, weekly jobless claims on Thursday, and a consumer sentiment survey on Friday.

Earnings, minus financials

Another source of hope for some investors is that earnings outside of the battered financial sector have continued to grow north of 11% in the fourth quarter, according to Thomson Financial.

The overall forecast for all S&P 500 firms, including financials, deteriorated slightly over the past week, with an estimated negative growth rate of 20.7% compared with 20.5% last week. The financial sector is expected to have seen earnings drop a whopping 105% in the fourth quarter, amid huge write-downs from the likes of Citigroup Inc. and Merrill Lynch & Co. .

The materials sector is the second worst, with earnings there seen losing 17% in the quarter because of the likes of Alcoa Inc. and Freeport McMoRan . The consumer discretionary sector, which includes home builders, is the third worst sector, with earnings there seen dropping 15% in the fourth quarter.

On the positive side, the technology sector, which has been among the most battered in the market in recent months, is expected to see the best growth in profits, with earnings there seen gaining 26% in the fourth quarter, led by companies such as Microsoft Corp. and Apple Inc. .

Next week, investors will turn to tech-bellwether Cisco Systems Inc.'s earnings on Thursday. The internet networking firm's Chief Executive John Chambers in November warned back in November that weakening demand, including from banks hit by bad loans, would hurt results.

"Cisco sort of started the whole meltdown in technology stocks since last year," said Deutsche Bank's Fitzpatrick. "It will be very important to see what they have to say for 2008, given the market's heightened sensitivity."

Disney , one of the Dow's 30 blue-chip stocks, is slated to report results on Tuesday.

By Nick Godt