Investors head into this week on the defensive as the potential for U.S. equity gains could be limited even if earnings begin on a strong note.
The early fourth-quarter results will set the tone. Any weakness will give traders a reason to pull back from the rally of recent weeks, which stalled on Friday on bank stock losses and lackluster jobs data.
Still, the major indexes finished with a sixth straight week of gains last week: the Dow was up 0.8 percent, the S&P 500 up 1.1 percent and the Nasdaq composite index ahead 1.9 percent.
It will be important to get out of the box with a positive note, said James Dunigan, who helps manage $105 billion at PNC Wealth Management in Philadelphia. If that's the case, we have a little way to run and can keep rising, but if the results disappoint there will be reason to step back.
The S&P 500 <.SPX> has climbed 7 percent since the start of December while Alcoa has soared 25 percent and JPMorgan has surged 16 percent. Analysts say that such rapid gains leave the market more vulnerable for a pullback and could limit upside potential.
GOOD, BAD AND UGLY
The S&P 500 has struggled to break above 1,280, though a floor appeared to be developing around 1,260, the 14-day moving average and near the 2010 close.
Jeffrey Friedman, a senior market strategist at Lind-Waldock in Chicago, said if results come in line or miss expectations we could see as much as an 8 percent pullback. Upside potential is 4 percent to 5 percent and that's only if earnings beat convincingly, he said.
Friday's December employment report could increase the likelihood of stocks' retreating. While the unemployment rate dropped by a hefty amount in December, far fewer workers were added than expected.
There's good, bad and ugly in that report, Friedman said. The good was the unemployment rate, the bad was that we didn't meet expectations, and the ugly is that we don't know whether the good or bad is more right.
This week will also see retail sales data on Friday, which will be closely watched following soft December comparable sales. On Wednesday the Federal Reserve will release the Beige Book.
The Beige Book, an anecdotal report on the economy by region, comes after Chairman Ben Bernanke gave his first congressional testimony since launching a second round of quantitative easing. Bernanke said on Friday the economy may be hitting its stride even if growth remains too weak to put a real dent in the U.S. unemployment situation.
Bank stocks could be pressured further this week after a ruling by Massachusetts' highest court that invalidated the seizures of two homes in foreclosure by Wells Fargo & Co
The KBW Banks index <.BKX> is up 18 percent since the start of December, but fell 0.9 percent on Friday.
The ruling could impact bank foreclosures nationwide and dampen recovery prospects for the real estate sector and banks, said Nick Kalivas, a senior equity index analyst at MF Global in Chicago. Financials have really been a leader in the market in recent weeks; this could close that sector out.