Investors continue to gather clues on whether the U.S. economy is headed toward recession, and next week's data and earnings releases will provide plenty. Last week, Goldman Sachs weighed in to predict the economy slides into recession this year, roiling stocks and pushing Treasury yields lower. Goldman's chief economist Jan Hatzius estimated declining corporate profits for the year to the tune of 7.5%, a 20% to 25% ultimate drop in home prices, and Federal Reserve rate cuts to 2.5% by late in the year. As if on cue, Fed Chairman Ben Bernanke
chimed in the following day with a concerning outlook for 2008. "Incoming information has suggested that the baseline outlook for real activity in 2008 has worsened and the downside risks to growth have become more pronounced," he said, opening the door for more aggressive easing of monetary policy. "We stand ready to take substantive additional action as needed to support growth and to provide adequate insurance against downside risks," he says. While most in the market believe Bernanke's speech sealed the deal for the Fed to cut the fed funds rate by 50 basis points come Jan. 29, some took his words to mean the Fed would consider emergency, or intermeeting, fed funds rate cuts. But an emergency rate cut requires an emergency. The Fed's coordinated global auctions via its new tool, the Term Auction Facility, have successfully lowered key interest rates like Libor, which ties directly to subprime mortgage resets. The third auction through the facility, recently raised to $30 billion, is slated for Tuesday. So, traders are left to ponder what the emergency trigger might be.
Next week may not bring such an event, but it may well bring some ugly economic and earnings surprises. Earnings were off to an unpleasant start last week, when aluminum producer Alcoa ( AA) unofficially kicked off the season with a weak report and comments about high energy costs and pressure from the weak value of the U.S. dollar. KB Home ( KBH) also missed analysts' expectations by a wide margin, as analysts further ratcheted down estimates for fourth-quarter financial sector profits. The combination has quickly driven down the overall fourth-quarter earnings growth rate estimate to a decline of 11% from last week's expected 9.5% decline. The financial sector's slump is expected to ring in at a whopping 71% decline, more than last week's still-dismal 66% expected profit growth drop. Key among next week's reports will be the financials, with Citigroup ( C), JPMorgan Chase ( JPM), Merrill Lynch ( MER) and Washington Mutual ( WM), among others. Financial stocks generally bucked the Dow Jones Industrial Average's almost 247-point drop Friday, as the sector rallied on hope for a fresh round of mergers following Bank of America's ( BAC) $4 billion
deal for troubled mortgage lender Countrywide Financial ( CFC) and rumors JPMorgan could be interested in WaMu. On the other hand, rumors have already swirled in the opening days of 2008 about greater writedowns expected from Wall Street's titans based on their exposure to the mortgage market and related structured products and derivatives. Several market participants have reported seeing some collateralized debt obligations, or CDOs, liquidating their assets, creating some new and lower price levels for mortgage-backed debt. Markdowns in the past have always meant writedowns. As for economic data, traders have a hefty calendar to digest, all of which is expected to reveal that the credit crunch of late 2007 has indeed spilled over into the real economy. With retailers' dismal December sales reports like Target's ( TGT) and Macy's ( M) still fresh in traders' minds, the week kicks off with the government's report of December retail sales on Tuesday. The following days are a barrage of data, including inflation gauges, such as the consumer price index and the producer price index. Wednesday brings reports on December's industrial production, capacity utilization and the Fed's intermeeting assessment of the economy, the Beige Book. A couple of regional economic reports for December come out next week as well. The New York Empire State index is expected to rise slightly, as is the Philadelphia Fed survey of manufacturing activity, which is released Thursday.