NEW YORK—In the heart of earnings season, U.S. stock market investors will scrutinize a raft of regional bank earnings this week for more write-offs that could send the market tumbling.
The S&P 500 and the Nasdaq snapped a six-week losing streak with financials helping to drive the market higher on the back of stronger-than-expected results from the likes of Citigroup, JPMorgan Chase and Wells Fargo. A sharp drop in oil prices also improved sentiment and lifted the market.
For the past week, the Dow Jones industrial average gained 3.57 percent, its best week in three months, while the Standard & Poor's 500 Index rose 1.71 percent and the Nasdaq Composite Index advanced 1.95 percent.
Still, while the week ended with financial services as the second-biggest boost to the S&P 500, regional banks were one of the heaviest drags. The S&P Regional Banks index ended Friday's session down 0.8 percent.
After U.S. banking regulators swooped in last Friday to take over IndyMac Bancorp Inc, making it the fifth U.S. bank to fail this year, investors will key in on regional bank results as a measure of how the U.S. banking system is holding up in a fragile economy.
"Most of the major financial institutions have reported, so there's going to be attention on the flow coming in from the regional banks. We'll be watching for write-offs on the regional banks," said Fred Dickson, market strategist and director of retail research at D.A. Davidson & Co in Lake Oswego, Oregon.
Bank of America Corp , the No. 2 U.S. bank, headlines the week with its Monday earnings report. Regional banks in the spotlight will be Regions Financial Corp, Fifth Third Bancorp, SunTrust Banks Inc and Wachovia.
The coming week will also usher in earnings results from large-cap companies, including Dow components Pfizer Inc , AT&T, and Caterpillar, as well as Nasdaq stalwarts Apple Inc, and Yahoo! Inc .
This "is going to be a heavy reporting week, so the continuing wave of second-quarter earnings reports will be important," Dickson said.
Bears on a Short Leash
This week also marks the start of an emergency rule introduced by the U.S. Securities and Exchange Commission that will limit certain types of short selling in the stocks of 19 major financial companies, including all the major investment banks as well as the huge mortgage finance companies Fannie Mae and Freddie Mac .
"The short-selling announcement last week really set the stage for the bounce in financials on Wednesday, and that's been a big psychological lift for investors," Dickson said.
Short sellers make bearish bets that a stock's price will fall. They arrange to borrow stocks they think are overvalued and sell them in hopes that the price will drop. If that happens, they can buy the stock back at a cheaper price and make a profit. On its own, short selling is a legitimate investment strategy.
But the SEC aims to curb abusive "naked" short selling, where investors have not actually borrowed the stocks before the short sale occurs.
On Sunday, July 13, the U.S. Treasury and the Federal Reserve unveiled a rescue plan for Fannie Mae and Freddie Mac in an attempt to shore up confidence that the twin pillars of the U.S. housing market will continue in that role.
The survival of Fannie Mae and Freddie Mac is deemed crucial to the soundness of the U.S. banking system because the two companies own or guarantee almost $5 trillion of mortgage debt -- or about half of all U.S. mortgages. They provide liquidity to the U.S. home loan market by buying mortgages and repackaging them into securities such as mortgage-backed bonds.
In the face of economic volatility, Federal Reserve Bank of Philadelphia President Charles Plosser will speak Tuesday about the economic outlook at a meeting of bankers, financial service providers, and business leaders.
On Thursday, Timothy Geithner, the president of the Federal Reserve Bank of New York, and SEC Chairman Christopher Cox are scheduled to testify before a House Financial Services Committee hearing on "Financial Market Regulatory Restructuring."
Last week, in two days of testimony to congressional committees, Federal Reserve Chairman Ben Bernanke painted a gloomier economic picture than he had in previous remarks. He urged lawmakers to approve the Treasury Department's proposals to back up mortgage markets.
"If you can see some of the stabilization in the likes of Freddie Mac and Fannie Mae, that will be a big positive, and gradually you're going to reinforce and renew the trust and confidence back into the system. That's what we're kind of waiting for and it will take time," said Alan Lancz, president of Alan B. Lancz & Associates Inc, an investment advisory firm in Toledo, Ohio.
Slower Home Sales, Wary Consumers
Investors will get more insight into the housing market this week when June existing home sales come out on Thursday and new home sales for the month are reported on Friday. Existing home sales are forecast to slow to an annual rate of 4.93 million units in June from May's pace of 4.99 million, according to economists polled by Reuters. New home sales are expected to dip to an annual rate of 500,000 units in June from a pace of 512,000 units in May, the Reuters poll showed.
Friday will shed light on consumer sentiment, when the Reuters/University of Michigan sentiment survey will be released. Analysts expect the final July reading to stay at June's 28-year low.
Oil's Biggest Weekly Drop
Oil may also determine the market's direction this week.
Last week, Wall Street and Main Street dared to hope that things might get better as the price of oil tumbled in its biggest weekly drop -- in dollar terms -- since oil futures began trading on the New York Mercantile Exchange in 1983.
Evidence of lower demand due to the weak economy helped drive U.S. oil futures for August delivery down nearly 13 percent on Friday to as low as $128.23 per barrel -- a drop of $19.04 from the July 11 record intraday high of $147.27.
NYMEX August crude settled on Friday at $128.88 a barrel, down 41 cents for the day.
But uncertainty created by geopolitical concerns and the potential for natural disasters could make the difference in whether oil prices continue their fall or shoot back up.
"If the economy keeps getting weaker, you may see oil tick off a bit more in the short term as demand slows. But the longer-term trend for oil is still higher," said Thomas Nyheim, vice president and portfolio manager at Christiana Bank & Trust Co in Greenville, Delaware.
Dickson of D.A. Davidson pointed out that "the fact is, we're moving into hurricane season so Gulf storms will always be on the radar. We also seem to have had an easing in tensions between Iran and Israel, but if something new brews there, that could reverse. It does seem the oil market has responded to some demand destruction in India and the possibility of less oil use in China as they gear down investor operations ahead of the Olympics."
