Updated from 10/08/11 to include news of a Franco-German agreement to recapitalize Europe's banks.

NEW YORK ( TheStreet) -- Dare we say that Europe's leaders are finally beginning to get it? Judging by the three-day rally this past week, it seems investors were quite encouraged by the comments of German Chancellor Angela Merkel and other officials.

What's more, Merkel reached agreement Sunday with French counterpart Nicolas Sarkozy on a plan to recapitalize Europe's banks.

The stock market is still a gambling game at this point and as Federal Reserve Chairman Ben Bernanke puts it, Americans are a bit like "innocent bystanders." But if all the leaders start singing one tune, stocks could ramp up again in the coming week.

Here's a recap of the previous five sessions: Monday's session was manic, again on global growth fears; Tuesday saw a dramatic late-day turnaround after investors got wind of the eurozone's recap plan talks; on Wednesday the market tacked on more gains helped by positive economic data; Thursday made it three positive days in a row ; and Friday got a bit freaky again after Fitch downgraded Spain and Italy and as the short-covering weakened.

Investors remain prisoners of volatility. Whether it's rating agencies calling the shots, the latest on the Dexia bailout, or speculation about a rescue plan in the works, all the important moving parts are in Europe. Just after the close Friday, Moody's put Belgium on review for a possible downgrade meaning that more bad news could be ahead. Next week, there's plenty of room for surprises still.

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Where We Are

Investors likely will be thrilled by Sunday's news of a European bank recapitalization plan, and it might be enough to dispel most of the gray clouds overhanging Europe. As High Frequency Economics puts it: "If banks are sound enough to withstand any possible shock, then no one cares if borrowers or governments fail to meet their obligations."

Sarkozy reportedly described the agreement as "total," although details remain scarce. Merkel and Sarkozy said they want to keep them under wraps until they can discuss their agreement with other European Union leaders. An EU summit meeting is scheduled for Oct. 17-18.

As the risk of a widespread default grows, banks will need more capital to quell investor fears about solvency. Central banks can provide liquidity, as the ECB has said it is committed to doing so, but only policymakers can address the issue of solvency.

Capital Economics estimates that haircuts of 25% on Greek, Irish, Portuguese, Spanish and Italian debt would roughly cost banks in those countries as well as banks in Germany and France a combined 200 billion euros. A worst-case scenario of 50% haircuts across the board would essentially double that loss to 400 billion euros, amounting to about 5% of the combined GDP of these economies. Already, Capital Economics reckons that "markets are fully pricing in this outcome."

Before banks can be recapitalized, however, officials still have to get the European Financial Stability Facility expanded. Of the 17 countries that need to approve the expansion proposal, 15 have ratified it. Votes from Malta and Slovakia are due on Monday and Tuesday, creating added uncertainty near the beginning of the week.

As for Greek's next round of funding, the troika creditors have decided to push back their decision until after the originally scheduled decision day next Thursday. That means there's a chance Greece could miss a crucial bond payment on Friday, raising the risk that the country might default. Many economists think that the country can muster enough money to get through Friday but that it will still default in the future.

Earnings Bright Spot

Through all of Europe's mess, one of the few areas of the economy that investors believe can help lift stocks is strength in profits of U.S. corporations. Investors are most interested in what companies have to say about guidance for the rest of the year.

Next week, third-quarter reporting season finally kicks off with Alcoa ( AA) on Tuesday. Quincy Krosby, market strategist at Prudential Financial, says that she will be listening closely to what Alcoa has to say about infrastructure building, customer demands and any substitutions in the company's use of construction metals.

"We want to hear what companies have to say about the global landscape," says Krosby. "When there's an ongoing slowdown, expect to see some misses," she adds, noting that banks and industrials are expected to bear the brunt of the economic pressures this season.

Other companies worth watching are Chevron ( CVX) on Tuesday, PepsiCo ( PEP) on Wednesday, and JPMorgan Chase ( JPM) and Google ( GOOG) on Thursday. Next week will only see a scintilla of key names, but it should bring more clarity on how much the economic slowdown has hurt consumer demand.

Key Data Points

On Friday, China reports inflation figures for September. After rising 6.4% on an annual basis in the prior month, economists predict an easing to 6.1%. This is expected because the rise in food prices has slowed slightly, according to Barclays Capital. The report is expected to give investors an indication of whether the Chinese government can take its foot off the gas in reining in growth. China's economic numbers have grown increasingly important as worries that emerging economies are facing slowdowns have increased.

The U.S. economic calendar looks light after a raft of manufacturing data this week as well as Friday's jobs report. The consensus is that the data points suggest that the economy is not falling into a recession but that growth is anemic.

On Tuesday, investors will be poring over the notes from the Federal Reserve's last two-day meeting in September. If investors find signs that some officials are pushing for more quantitative easing, stocks could see a temporary move up.

The minutes might indicate what other options were in the running before the Fed announced Operation Twist, such as leaving short rates near near-zero until the unemployment rate drops below a certain level.

"Any hint that officials did give these options the once-over will lead to speculation that they might be implemented at the Fed's next meeting on Nov. 2 ," according to Capital Economics.

Other indicators include retail sales on Friday, which economists expect will continue to improve as effects from the Japanese earthquake ease and motor vehicle sales rebound. The University of Michigan's consumer confidence measure for October, also out on Friday, is expected to remain weak given the persistent stock market volatility into this month.

-- Written by Chao Deng in New York.

>To contact the writer of this article, click here: Chao Deng.

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