The US stock market landed at a technical crossroads following its best week in a year, yet the potential for positive earnings surprises beginning next week could give an edge to the bulls.
Analysts turned increasingly bearish before the start of earnings season. Sentiment stands at its lowest since May 2009, according to a Bespoke Investment Group note that said analysts have lowered estimates for 572 companies in the S&P 1500 in the last four weeks, while they raised expectations for 396.
At the same time, bullish investor sentiment as measured by the American Association of Individual Investors fell to just 21 percent last week, the lowest since early March 2009 - right at the market's bottom.
Equity funds world-wide saw more than $11 billion in net outflows in the first week of July, while money market funds attracted the biggest inflows in 18 months, fund tracker EPFR Global said.
"Expectations are low going into the results, so we could have some positive surprises there and the big test will be if we can get back above 1,100 (on the S&P 500)," said Paul Hickey, a co-founder of Bespoke, based in Harrison, New York.
The Standard & Poor's 500 Index ended slightly higher on Friday at 1,077.95. Even with signs of dwindling sentiment, analysts still expect 27 percent growth in earnings on the S&P 500 for the second quarter according to Thomson Reuters data. That is up from previous readings in the past three quarters, which hovered around 22 percent. To be sure, beating top and bottom line expectations could still prove a Pyrrhic victory. chief executives must also provide outlooks that convince investors the US economy does not face a double-dip recession or the European credit crisis will not damage future earnings.
"Everybody's concerned about the economy and the market has reflected these concerns," said Cleveland Rueckert, equity strategist at Birinyi Associates in Stamford, Connecticut.
"Right now the market has priced in a slowdown in earnings, so we're going to see a lot of focus not only on the reports but also the guidance," he said. After regaining the key 1,040 level earlier this week, the S&P 500 also generated a 'buy' signal in its moving average convergence-divergence, or MACD chart. But its 50-day simple moving average is still below the 200-day moving average. This so-called death cross is seen as a signal of further downward pressure.
The index also stands at its 20-day moving average, which leaves it right in the middle line of its Bollinger bands, meaning it technically has space to move in any direction, and leaves it susceptible to volatility.
"We're seeing a tug of war between technical indicators," said Brian Jacobsen, chief portfolio strategist at Wells Fargo Funds Management in Menomonee Falls, Wisconsin. "You're going to see people migrating toward one end of the camp or the other depending on how the earnings season plays out." Amid the lack of technical guidance, options traders seem to be hedging themselves for some volatility. On Friday, the most active trades on the SPDR S&P 500 fund were the July $107 calls and the July $107 puts. "The volume is nearly the same for calls and puts, so these just look like bets on volatility next week instead of a direction," said Ryan Detrick, senior technical strategist at Schaeffer's Investment Research in Cincinnati, Ohio.
Big names like Google Inc, Intel Corp, J. P Morgan Chase & Co and Bank of America Corp will post their quarterly scorecards in a busy week that will see Alcoa Inc start the season after the market's close on Monday.
J. P Morgan will be in focus as many investors expect financials to lead or take part in a stocks comeback. But the bank is expected to post earnings of 67.9 cents per share according to StarMine's SmartEstimate, which weights estimates according to analysts' accuracy, versus the mean of 72 cents a share.
If J. P Morgan does miss median expectations, it could threaten this nascent stocks rally. More than a few Dow components posting earnings could overshadow the economic data, but the minutes of the latest Federal Open Market Committee meeting, expected Wednesday, will be closely watched as they will provide a window into the Fed's take on the extent of the effect of the European credit crisis in US growth.
Other data high points include business inventories Wednesday, the Producer Price Index and initial applications for unemployment benefits on Thursday and the Reuters/University of Michigan survey of consumers on Friday.
Overseas data includes Chinese gross domestic product due on Thursday and expected to show a slowdown to 10.5 percent year-on-year growth from 11.9 percent.
"If people see a higher number they might think China is going to really rein in their economic growth, which could then put downward pressure on commodity (and US equity) prices," Wells Fargo's Jacobsen said.