The market’s optimism continued to be tested last week by a number of economic indicators that have either weakened or fallen short of expectations, a disappointment after several months of hopeful signs on key industries like housing and manufacturing.  That led investors to question whether the 50% surge in stock prices over the past six months can be sustained.  With the S&P 500 barely above its 50-day moving average around 1020, a key support level, traders appear increasingly risk-adverse in front of the upcoming earnings season.

Stocks meandered last Friday, at the end of a second straight week of losses, as investors worried that a worse-than-expected jobs report was further evidence that the stock market rally had gotten ahead of the economic recovery.   Last Friday, the Dow fell 21.61, or 0.2%, to 9,487.67, after falling 79 points at one stage. The Standard & Poor’s 500 index fell 4.64, or 0.5%, to 1,025.21, and the Nasdaq composite index fell 9.37, or 0.5%, to 2,048.11.  For the week, the Dow and the S&P 500 index each lost 1.8%, while the Nasdaq fell 2%.  Stocks are coming off a banner third quarter. Both the Dow and the S&P 500 index gained 15% in the July-September period. 

Two stocks fell for every one that rose on the New York Stock Exchange, where volume came to 1.4 billion shares compared with 1.6 billion Thursday.

An indicator of investors’ rising discomfort with equity valuations, the CBOE Vix “fear factor” index jumped 12% over the past week.  The deterioration in risk sentiment appears hinged on the prospect of a “W-shaped” recovery.  HSBC (NYSE:HBC) CEO warned, “I’m cautious about growing too fast.”  “Is this a V recovery or a W?  I think it’s the latter.”  At the Group of 7 meeting, NYU Professor Nouriel Roubini also agreed and cautioned that equity values have risen “too much, too soon, too fast,” and predicted that both stocks and commodities may fall in upcoming months until investors fully acknowledge the sluggish pace of this recovery.

This week’s slow calendar may offer a brief respite before the reality of third quarter results sets in.  The main events include today’s reading on the services sector, which accounts for well over 70% of economic activity. The news may offer solace if results meet the consensus estimate of 50, the mid-point between contraction and expansion, up from the prior 48.4.

Another key event for the week will be Thursday’s release of September same-store-sales. Comparable sales should have proven somewhat easier; however, consensus estimates call for a decline of 1%-2% from September 2008.   Soft returns may point to another weak holiday season, with consumers remaining cautious as unemployment continues to climb.  According to former Fed Chairman Greenspan, however, third quarter economic growth could be as much as 3%, despite unemployment levels likely to move even higher. Wal-Mart (NYSE:WMT) Chairman Rob Walton also warned of a slow US recovery.  The G-7 finance ministers cautioned that “there is no room for complacency since the prospects for growth remain fragile and labor market conditions are not improving.”

Troubled lender CIT (CIT) launched a debt-exchange plan as part of its efforts to restructure and avoid bankruptcy. But the company said if the plan is not successful, it will likely file for Chapter 11 protection.   First Solar (FSLR) surged after it replaced Wyeth in the S&P 500.  Shares of Echo Global Logistics (ECHO) begin trading after the freight and cargo company raised $80 million in a share offering.

According to Bloomberg data, S&P 500 companies are expected to report a 23% third quarter fall in operating earnings, adding to their longest string of profit decline since the Great Depression.  Alcoa (NYSE:AA) is due to release results on Wednesday.  Others slated to release earnings this week include Robbins & Myers (NYSE:RBN) and Mosaic (NYSE:MOS) today, Yum Brands (NYSE:YUM) and Pepsi Bottling (NYSE:PBG) on Tuesday, Costco (NASDAQ:COST), Family Dollar (NYSE:FDO) and Monsanto (NYSE:MON) on Wednesday, and PepsiCo (NYSE:PEP) and Marriott (NYSE:MAR) on Thursday.

Zacks Investment Research