Stocks Spring Forward, With Trepidation

M&A helps spur modest gains ahead of brokerage earnings and amid more subprime worries.
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The market had daylight-savings jet lag Monday. But a subdued mood was just as well, as there wasn't much to energize traders but sunnier weather.

There was a flurry of merger and acquisition activity, which is always a bullish sign. But M&A news was countered by news of default notices for subprime problem child

New Century Financial

(NEW) - Get Report

.

Stock market volume was weak, as traders braced for

a week chock full of clues on the market's and the economy's direction. Tuesday's report of February retail sales and

Goldman Sachs'

(GS) - Get Report

kickoff to brokerages' earnings season could provide a kiss of death or a confidence boost.

The

Dow Jones Industrial Average

gained 0.34% to close at 12,318.62 while the

S&P 500

added 0.27% to 1406.60. The

Nasdaq Composite

finished the day up 0.62% at 2402.29.

Stocks' resilience depends somewhat on whether the brokers reveal how much negative spillover there's been from exposure to the subprime mortgage market or from trading in related subprime mortgage securities.

In addition to Goldman,

Lehman Brothers

(LEH)

and

Bear Stearns

(BSC)

report fiscal first-quarter earnings this week.

Morgan Stanley

(MS) - Get Report

, which Monday pulled its $265 million financing package for New Century, reports next Tuesday.

The scuttlebutt on Wall Street suggests that the losses for the investment firms were in the billions of dollars via bad trades or exposure to bad loans -- or both.

If the brokers manage to make good on, make up for, or explain away whatever hits they've taken due to their subprime exposure, the market may weather the storm without a credit crunch or other financial crisis. Credit spreads on corporate bonds can stay tight and lending standards can remain somewhat lax.

But if the world's marquee financial institutions trip up even more on the subprime story, investors may run farther and faster away from risk, as institutions respond by offering stricter access to capital, as

Countrywide Financial

(CFC)

announced Monday.

For now, however, the credit crunch is still not under way. While residential mortgage lending standards have tightened somewhat, there is no contagion. Mortgage refinancing applications rebounded last week, and the

Federal Reserve

released data late Friday that bank credit expanded rapidly in the week ended Feb. 28, notes Tony Crescenzi, chief fixed-income strategist at Miller Tabak, and

RealMoney.com

contributor.

Bank credit increased by $34 billion in the week to $8.41 trillion, following five weeks of other large gains. Crescenzi adds that bond issuance last Wednesday and Thursday totaled $20 billion, or five times average.

Also, the brokerage stocks have not exactly outperformed lately -- perhaps accounting for the subprime debacle. Indeed, most have done far worse than the broad market and their related indices. Goldman was up 0.5% Monday, but it is down 8.3% from its Feb. 21 peak; while Lehman and Bear also rose Monday, they have both dropped 10.7%. Morgan Stanley, up a fraction Monday, is down 10% from its 2007 peak, while

Merrill Lynch

(MER)

has slid 14.4%, but was up 0.7% Monday.

The Amex Securities Broker/Dealer Index has fallen 5.4% from its Feb. 20 high, while the KBW Bank Index has slid 8.9%.

"There's billions of dollars of exposure spread all over the bulge bracket firms, minus the collateral backing the loans," says Art Hogan, chief market analyst at Jefferies & Co. "I just don't think this is a financial system-melting event."

Hogan notes that even if the brokerage earnings don't result in disaster, they won't necessarily lead to a rally either. In each of the past three quarters,

Goldman usually beats expectations by far, thus setting the bar "too high" for the others, who inevitably disappoint.

Either way, investors might be well-served to stay away from the financial sector, writes John Roque, chief technical analyst at Natexis Bleichroeder. Citigroup's inability to follow through on a late-2006 rally combined with "weakening absolute and relative momentum" for the banking indices and "it is a good idea to stay defensive here," he writes, adding that the financials account for 21.8% of the S&P 500.

"Further weakness in financials will be a negative sign," he writes. Roque says investors should be watching breadth, or the net amount of advancing stocks on the

NYSE

, and the 10-day moving averages of new highs and lows for clues to the market's future. "New highs must rise and new lows must collapse for long-only investors to regain control," writes Roque. Until then, the correction isn't over, he writes.

Analysts expect retail sales for February to rise 0.3% after a disappointing flat month in January. For now, most economists believe that strong income growth and a tight labor market underpin continued strength in consumer spending.

At the start of March, the Commerce Department reported that personal income and spending rose more than expected in January, remaining above 5% year over year. The strength suggested that the consumer's strong addition to fourth quarter growth strength might spill into 2007. Consumer spending comprises two thirds of U.S. GDP.

Meanwhile the M&A mania that gripped stock market bulls ahead of the tumble on Feb. 27 is less manic and less hyped by the bulls now. A hefty slew of deals failed to provide a strong rally Monday.

Schering-Plough agreed to buy a unit of Netherlands company Akzo Nobel for $14.5 billion. Schering-Plough gained 0.4% on the day.

UnitedHealth agreed to buy Sierra Health Services for $2.6 billion, sending Sierra shares up 15.8%.

Kohlberg Kravis Roberts emerged to announce a $7 billion offer for Dollar General , which gained 25.6%.

But the market's mood is no longer about pure, raw appetite for stocks. It's about waiting and watching for the right clues and the right moment to step back into the fray.

In keeping with TSC's editorial policy, Rappaport doesn't own or short individual stocks. She also doesn't invest in hedge funds or other private investment partnerships. She appreciates your feedback. Click

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to send her an email.