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Market Preview: Debt Drama Enters Final Lap

NEW YORK (TheStreet) -- All the consternation about the debt-ceiling drama on Capitol Hill has enabled this headline-driven market to move past Monday's poor manufacturing data fairly quickly but that could be a very big mistake.

Coming off Friday's weak second-quarter GDP growth of 1.3% (and the more disturbing revision lower of first-quarter GDP to 0.4% from 1.9%), the possibility of the economy not just slowing its rate of recovery but slipping into recession is suddenly very real.

Research firm Capital Economics called Monday's weak ISM report for July "a shocker" and raised a warning about its larger ramifications for economic growth assumptions for the rest of the year.

"The index is not flagging up another recession (at least not yet) but it suggest that the easing in GDP growth in the first half of the year is looking more and more like a sustained slowdown than a short-lived soft patch," the firm wrote, adding later: "Most eye-catching, however, was the drop in the new orders index to 49.2 from 51.6. That's the first sub-50 reading since the recession ended. This is particularly worrying when this index is the most forward-looking component of the survey."

Not encouraging stuff. Remember, for all the data getting spit out by the government on a weekly basis, GDP has too many moving parts to measure accurately in a timely manner. That's why we were already deep in recession last time around before we could pinpoint when it started. Believing the guesstimates is risky, and under these conditions, it may be safer for investors to assume the worst about the economy's momentum than hope for the best.

The political fallout from the compromise legislation will continue to grab attention on Tuesday as the Senate still needs to approve on the bill, and President Barack Obama would then need to sign it into law ahead of the midnight deadline to raise the federal government's debt limit above $14.3 trillion.

The bill, which is widely viewed as a victory for the Republicans, provides for a two-step increase of the debt ceiling and creates a bipartisan supercommittee to find sufficient deficit reductions to support the second boost. Most market watchers still feel the U.S. will likely face a downgrade of its credit rating, possibly as soon as the end of this week.

Meanwhile, earnings season is coming into the final turn and, all in all, the numbers look pretty good. So far, 66% of the S&P 500's components have reported, and the blended quarterly earnings growth rate rose to 10.3% as of July 28 from 9.8% on July 1, and 74% of the companies have topped the consensus view. That's well down from 18.9% growth in the first quarter, but the easing was expected as year-over-year comparisons began to get tougher this quarter.

The only hiccups appear to be that growth expectations have ticked lower for the third quarter to 16.4% as of July 28 from 17% on July 1, and the ratio of negative preannouncements to positive ones, 2.4-to-1, remains well above a 1.1-to-1 ratio in last year's second quarter.

Tuesday's earnings slate is headlined by Dow component Pfizer (PFE). The average estimate of analysts polled by Thomson Reuters is for a profit of 59 cents a share in the June period on revenue of $16.98 billion, and the drug giant is looking for a sixth straight upside surprise.

Year-to-date, the stock is up 10%, lapping the 5% appreciation for the Dow Jones Industrial Average, so the expectations are high. Of the 22 analysts covering the stock, 18 are at strong buy (7) or buy (11), and the median 12-month price target sits at $23, implying potential upside of more than 20% from current levels.

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