New week, same worriesConcerns about inflation and interest...

New week, same worries
Concerns about inflation and interest rates aren't going away, but earnings could provide a distraction.
By Alexandra Twin, CNNMoney.com senior writer
April 9, 2006: 7:41 AM EDT


NEW YORK (CNNMoney.com) - Deja vu?

Investors returning to work Monday hoping for a break from last week's whipsawing may be disappointed. The week ahead is likely to be just as volatile, and it all hits a lot faster, with only four trading days in play.





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All financial markets will be closed Friday for the Good Friday holiday. Ahead of that, there's plenty to keep the bulls and the bears busy, including the start of the earnings reporting period, which unofficially begins with Alcoa's earnings Monday. (See chart for details)

Investors spent last week -- the first of the second quarter -- lurching between the bullish trends that tend to dominate early April and the bearish evidence that interest rates and inflation are on the rise. That evidence included gold prices at a 25-year high, oil prices back near all-time highs and a jump in long-term bond yields that pushed the 10-year note yield to a four-year high.

A strong March jobs report Friday showed a booming labor market paired with low unemployment. Such a scenario is good for workers, but also suggests the kind of inflation in so-called resource utilization that the Federal Reserve has been hinting at.

"The market took the report as a sign that a 5 percent Fed funds rate in May is a near certainty, with decent odds being put on a 5.25 percent rate in June," said Wan-Chong Kung, senior portfolio manager at First American Funds.

The Fed funds rate, a key short-term bank lending rate, currently stands at 4.75 percent. The Fed has boosted the rate 15 consecutive times since June of 2004.

The report also again reminded investors that when the Federal Reserve policy makers said future rate hikes are going to be dependent on the data, they meant it.

Because of this, markets are going to stay focused on anything inflation related in the week ahead, Kung said. She noted that the February trade balance and the capacity utilization and industrial production numbers are probably the most relevant. (For details on next week's reports, see chart.)

However, more than the reports, it will be the bond market's reaction to the reports that cues stocks in the weeks ahead, analysts say.

"Bonds will hold the wild card going forward," said Steven Goldman, market strategist at Weeden & Co.

Looking to the bond market
On Friday, the yield on the benchmark ten-year note finished at 4.98 percent, its highest level in nearly four years and not far from 5 percent, a key level.

Some analysts argue that bonds will become more appealing to investors seeking stronger returns when the yield is above 5 percent. Treasury prices and yields move in the opposite direction.

"If we continue to see sharp hikes in yields, then stocks will face tougher competition from bonds," Goldman said. "But if bond yields can stabilize here, or just move up modestly, stocks can tough it out."

Goldman noted that there are many supportive factors in place that will continue to help stocks, even as Treasury yields rise, including the underlying strength of the economy and the fact that the recent stock advance has been so broad.

The Nasdaq composite closed at its highest level in five years in the middle of last week, while the S&P 500 closed at its highest level in nearly five years. Both major stock gauges ended the week not far from such heights.

The Dow industrials hit a 4-1/2 year high in late March and sits not far from that now. The Russell 2000 -- the key benchmark for small-cap stocks -- hit an all-time closing high Wednesday and ended the week just below that level.

While the span of the advance gives the stock market some support, as Goldman said, it also makes equities vulnerable to a big pullback, as wary investors cash out of recent winners to lock in profits.

"Over the next few trading sessions, it will be important to watch whether the stock market sells off on rising volume," said Michael Sheldon, chief market strategist at Spencer Clarke. "If that should happen, that could mean a spring correction is on the way."

Earnings tiptoe out
Only eight S&P 500 companies report results this week, but since they get the ball rolling, they'll be important.

Alcoa, as is traditional, is scheduled to be the first Dow 30 component to report results. The aluminum maker's report is due after the close of trade Monday. Of greater interest will be earnings from fellow Dow component General Electric, tentatively scheduled for Thursday, as the company has often been seen as something of a proxy for the broader economy.

First-quarter S&P 500 earnings are expected to rise 10.4 percent versus a year earlier, according to tracking firm First Call/Thomson Financial. Reported earnings tend to be a bit higher than forecasts, suggesting earnings will probably rise about 14 percent in the quarter, said John Butters, a senior research analyst at Thomson.

That should make the first quarter the 11th in a row in which earnings grew at least 10 percent from the previous year, he added.

"The energy sector is once again expected to show the strongest year-over-year growth," Butters said. "Strip out energy, and overall earnings drops to 6.5 percent.

Energy earnings are currently on track to grow 40 percent versus a year ago. The telecom sector is second, with expected earnings growth of 21 percent. Materials is the weakest sector, and the only one expected to show a slowdown in earnings versus the same quarter a year ago, of about 4 percent.

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