Despite a mediocre earnings season and signs of an overbought market, Wall Street bulls are likely to remain in control this week.
So far in this earnings season, 352 companies in the S&P 500 have reported results, of which only 63 percent have beaten Wall Street estimates. This compares to a beat rate of about 70 percent on average for the past four quarters and would be the lowest since the fourth quarter of 2008.
Usually, strong earnings are associated with stock market rallies and improved investor sentiment. But despite this season's relatively weak results, the S&P is up nearly 7 percent for the year, and the index has posted gains for every single week in 2012, except for a 0.2 percent loss last week.
The demand for risky assets is strong. There is steady buying in the market, and the money is constantly being put to work, said Brian Lazorishak, portfolio manager at Chase Investment Counsel in Charlottesville, Virginia.
The market is sort of overlooking the weak 2011 earnings and looking forward to an improved 2012 earnings season ... It's like a green light to investors to get into risky assets.
There are a number of catalysts that have helped the market this year, including a slew of improved economic data and the Federal Reserve's vow to keep interest rates low.
Fed Chairman Ben Bernanke last week reiterated his plans to hold interest rates at record lows until late 2014. Many economists were looking to see if Bernanke might waver on that stance after news that hiring surged in January and the unemployment rate fell to a three-year low of 8.3 percent.
Also the Institute for Supply Management said its services index rose in January to its highest since February 2011.
Earnings upgrades by sell-side analysts tend to move in line with economic momentum, with global earnings momentum typically turning positive when the ISM new orders moves above 52, said Credit Suisse Group AG's analyst Andrew Garthwaite.
Yet, new orders are now at 57, and earnings momentum continues to be clearly negative, he said, adding that this was a problem but not necessarily bearish for markets.
The S&P 500 slid 0.7 percent on Friday, its biggest percentage decline so far in 2012 after an about-face on Greece's long-awaited debt deal ended a five-week streak of gains for equities.
Investors have anxiously awaited a bailout package for Greece so the country could avoid a messy debt default, but complications have tied up talks for weeks.
An agreement finally came last week but it was dealt a blow as Greek workers went on strike to oppose fiscal reform measures requested by the European Union and International Monetary Fund. Greek Finance Minister Evangelos Venizelos said the nation needs to reach a decision within days on accepting the terms of a bailout.
This week, 51 S&P 500 companies are expected to report earnings. The earnings growth rate for the S&P 500 for the fourth quarter of 2011 is now at 8.9 percent, according to Thomson Reuters I/B/E/S. However, excluding Apple
MORE VOLATILITY EXPECTED
Despite the optimism in the stock market, options traders are bracing for more volatility ahead.
Wall Street's favorite pulse of investor sentiment, the CBOE Volatility Index <.VIX>, or VIX, jumped nearly 12 percent to 20.79 after peaking at 21.98 on Friday. The VIX, a 30-day risk forecast of expected stock market volatility conveyed by S&P 500 <.SPX> option prices, typically moves higher when stocks decline.
The sharp move up in the VIX, especially over the last hour, suggests that there is serious concern over the European debt crisis and traders are looking to options to protect their equity positions heading into the weekend, said optionMonster analyst Chris McKhann.
If these volatility buyers are correct, then Monday could be ugly for equities.
Typically the options risk gauge is relatively weak on a Friday as traders factor in time decay in the price of the SPX options. But the daily percentage move was huge on Friday. The VIX logged its biggest daily percentage gain in three months, given that the S&P is down less than 1 percent.
VIX futures also made very large moves to the upside. The February futures, which have only two days of trading left, jumped 12.5 percent to 22.50. The contract closed at 21.75.
Shares also advanced in the TVIX, the VelocityShares Daily 2X VIX short-term, exchange-traded note, which is designed to gain or lose at twice the rate of the underlying index on a daily basis. The leveraged ETN, based on the front two-month VIX futures, gained 17.14 percent to $19.07, and is now more than 50 percent in value over the past four sessions.
This suggests that traders are paying up to buy volatility as a hedge against a continued decline, McKhann said.
Economic indicators due this week include retail sales on Tuesday and industrial production on Wednesday. On Thursday, housing starts, jobless claims and the producer price index are due. The consumer price index will be released on Friday.
(Reporting By Angela Moon; Additional reporting by Doris Frankel in Chicago; Editing by Kenneth Barry)