Wall Street Week Ahead: Torn between bulls and bears

NEW YORK (Reuters) - Monday morning will be decision time for traders and investors: Should they buy or sell after Friday's steep decline that pushed the S&P 500 below its 200-day moving average?

While comments out of Europe over the weekend point to signs of a more urgent push for a fiscal union the euro zone, that may be not enough for the market that just saw the Dow turn negative for the year and the S&P 500 dip below the critical 200-day moving average for the first time since December - a level that many technical analysts view as the border between a bull and a bear market.

"The sentiment backdrop continues to grow more pessimistic and remains consistent with negativity seen at major bottoms during corrective pullbacks the last few years. Hedge funds are no longer showing interest in stocks," said Todd Salamone, director of research for Schaeffer's Investment Research in Cincinnati.

"The risk to bulls is that the sentiment backdrop worsens from here, but bears should also be on guard for a reversal in the sentiment backdrop, as major short-covering could follow," he said.

Spanish Prime Minister Mariano Rajoy on Saturday called for the establishment of a central authority that would oversee and coordinate fiscal policy in the euro zone. Germany also wants a big leap forward in euro integration, but investors are doubtful whether the closer integration could restore market confidence.

"There's no doubt that any kind of a show of a more aggressive move by policymakers is helpful. But the market has gotten used to the fact that the sharper the fall on a Friday, there's likely going to be some action or rumored action forthcoming in the following week," said James Paulsen, chief investment strategist at Wells Capital Management in Minneapolis.

For the week on Friday, the Dow Jones industrial average fell 2.7 percent, the Standard & Poor's 500 index <.spx> slid 3 percent and the Nasdaq composite index <.ixic> fell 3.2 percent. Both the Dow and the S&P 500 are off about 10 percent from their recent peaks, a retreat that would mark a so-called correction.

FED IN FOCUS

Federal Reserve Chairman Ben Bernanke will be back on Capitol Hill on Thursday to testify before a congressional committee about the state of the U.S. economy. He's not going to get an easy ride.

"This puts the Fed firmly in play and they will likely feel compelled to respond," said Tom Porcelli, chief U.S. economist at RBC Capital Markets in New York, after data on Friday showed U.S. job growth in May was the weakest in a year.

"The missing ingredient preventing the Fed from action had been the equity market, but now we are seeing it softening," he said. "Equities are falling and that was the last hurdle for Fed policy action because all the other criteria have been met."

The Fed's next policy meeting occurs on June 19-20. A Reuters poll of 15 dealers gives a 35 percent chance of the Fed extending its stimulative "Operation Twist" at that meeting. The poll showed that dealers expecting further quantitative easing, or QE3, rose to 50 percent from 33 percent in May.

Stock market rallies in each of the past three years were fueled by combinations of massive central bank and government stimulus spending. That may be the only hope for equities this year, too.

The world's economic outlook darkened on Friday as reports showed U.S. employment growth had slowed, Chinese factory output barely grew and European manufacturing fell deeper into malaise.

"It certainly suggests that perhaps the softness in Europe is either influencing the U.S. or that the U.S. recovery may not be strong enough to overcome the softness in Europe," said Jack Ablin, chief investment officer of Harris Private Bank in Chicago.

"I underestimated the relationship or the alignment of the world markets to the European markets," he said. "I felt that Europe could potentially proceed in their own little corner of the world. For right now anyway, it just doesn't seem that way."

Nothing tells the story of the global economy at the moment better than the world's equity markets.

Bear markets are raging in Spain, Italy, Brazil and Russia. Asian stocks have been weak. Most of Europe's other markets are negative for the year, and that is where U.S. stocks are going - and fast.

"I don't see any compelling reason to think that we are going to have any sustained recovery absent new fiscal, monetary stimulus, not only here in the United States, but perhaps even more importantly elsewhere around the world," said Clark Yingst, chief market analyst at Joseph Gunnar.

Yingst said that signs of more stimulus may be a compelling reason to get bullish.

We will be "watching very closely for new fiscal and monetary stimulus from a variety of countries. I think the source will be important, I think the magnitude, the scope will be important," he said.

MORE UNCERTAINTY AHEAD

Greece will face new elections in two weeks. A victory for parties that oppose the bailout led by the European Union and International Monetary Fund could start the ball rolling on the country's withdrawal from the euro zone.

Such an event would have unforeseen consequences for the global economy and financial markets. Part of the 6.3 percent drop in the S&P 500 in May - its worst month since September - was about pricing that in.

But it is anyone's guess how far stocks will fall if a Greek exit sparks the Lehman-type event that some investors fear.

Fears that the euro-zone debt crisis is spilling over to the United States sparked fresh buying of U.S., German, Japanese, Swiss and Nordic government debt, which are perceived as safe havens in times of market turbulence.

Yields on the benchmark 10-year Treasury note hit 1.442 percent, the lowest level in records going back to the early 1800s.

At the same time, funding options are narrowing for companies across the globe as issuers are shut out of markets due to risk aversion for weaker credits and demand for spread that is sending costs soaring.

Volume in the robust U.S. investment-grade market has dwindled from $284.8 billion in the first quarter to just $118.7 billion in the first two months of the second quarter, according to data from IFR, a unit of Thomson Reuters. That number is expected to fall even more in the summer.

But not everyone is hitting the "sell" button.

Zahid Siddique, an associate portfolio manager of the Gabelli Equity Trust, said his two- to four-year time horizon and focus on value is allowing him to add to positions in sectors that are getting hit the hardest.

"Companies that we liked before are becoming more attractive from a valuation perspective and we have been buying more of those," he said. "We just buy on any dips and exit when valuations reach our assessment of value."

Siddique said he'd been adding to holdings in auto suppliers, aerospace and consumer sectors.

(Reporting By Edward Krudy and Angela Moon; Editing by Kenneth Barry and Jan Paschal)

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