Wall St week ahead: Taxes, inflation data to dominate week

Courtesy : Moneycontrol

Without a boost from Washington policymakers or data showing budding strength in the economy, Wall Street's rally may be running out of fuel as the S&P 500 eases off its 2010 high.

A data-heavy week could give investors hard evidence to justify a rally that lifted the S&P 500 16.8 percent from its August 31 close to the 2010 closing high hit last week.

But the index has been unable to move above 1,228, a key resistance level, and its chart is brewing a double-top formation, a very bearish signal.

"We're susceptible to a pullback if we don't get any clarity on fiscal policy and if any of this economic data disappoints next week," said John Lynch, chief equity strategist at Wells Fargo Funds Management in Charlotte, North Carolina.

"I would think you're going to see some, not all, smart money pull their investment (out of stocks) the closer we get to 1,228. These guys recognize we still have above 9% unemployment, sovereign credit risks, a consumer deleveraging and no clarity as to what businesses should do with their cash."

For the week, the Dow Jones industrial average and the Standard & Poor's 500 index each fell 2.2%. The Nasdaq Composite index lost 2.4%.

The S&P 500 brushed the 61.8% retracement of its slide from the historic highs in 2007 to the low in March 2009.

This was the second time the index backed away from the 1,228 area and its chart could be drawing a bearish "double top" formation. The last retreat from that level, in April, was the start of a correction that took the S&P to its 2010 low in July.

The S&P 500 dipped on Friday below its 20-day moving average for the first time since September 1 but managed to close above it in a sign that that level, currently just above 1,194, could provide strong technical support.

Let's talk about taxes

Investors will closely watch a meeting next Thursday between US President Barack Obama and congressional leaders to discuss policy, including tax cuts.

Republicans will take control of the House of Representatives starting in January following their strong gains in the November 2 elections. They have vowed to force a full extension of all tax cuts enacted during the administration of President George W Bush. Otherwise, the tax cuts expire at the end of 2010.

Most of Obama's Democrats favour extending tax cuts only for the first USD 200,000 of income of individuals and USD 250,000 for families.

"Bush tax cuts are very important for the market," said Michael Yoshikami, president and chief investment strategist at YCMNET Advisors in Walnut Creek, California.

"If they're not renewed, that could cost 0.75 percentage point per year in GDP (growth). I don't think any other proposal would have that kind of significant impact. If dividend taxes were raised, that would be a still important but more minor issue," he said.

Many Democrats argue that renewing all the tax cuts would swell the record US budget deficit and have little, if any, impact on cutting the high unemployment rate.

Data back on the table

Following a week in which the few macroeconomic indicators barely influenced stocks, a slew of data ranging from manufacturing to leading indicators to retail sales, and, perhaps most importantly, inflation, will return investors' attention to market fundamentals.

Producer prices are expected to have risen 0.8% month-over-month in October. The US government measure, out on Tuesday, could add to concerns following September's rise, which was twice what analysts expected. With little leverage to pass on costs to cash-strapped consumers, businesses may have to swallow any price hikes, weakening margins and profits.

The year-on-year consumer prices index, due on Wednesday, is expected to show a dip to 0.7% from 0.8% in September when food and energy prices are excluded.

Consumer staple companies highlighted "concerns about rising commodity costs and to what extent are businesses able to pass costs through the chain," said Wells Fargo's Lynch.

He pointed to businesses willing to absorb much of those price hikes, "which would be consistent with my perception that earnings and margins estimates for next year are too high."

On Monday data could show retail sales gained in October, while a separate report on September inventories could detail unwanted supply piling up at businesses.

Federal Reserve Chairman Ben Bernanke could provide a signal on the strength of the Fed's bond-buying commitment in remarks in Frankfurt on Friday.