Wall Street Week Ahead: Line drawn in stocks' battle

Features Reuters

By Edward Krudy

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NEW YORK (Reuters) - The S&P 500's 200-day moving average is the line in the sand as the bulls and the bears fight over the U.S. stock market's direction. It will face one of its stiffest tests next week with Greece's debt crisis appearing to reach a climax.

After setting its closing high for the year on April 29, the S&P 500 has lost 7 percent. Wall Street typically defines a drop of 10 percent or more from a recent peak as a correction.

The benchmark S&P 500 hit its lowest point right on its 200-day moving average in volatile trading on Thursday. The index then rallied 1 percent from that session low to close on Friday at 1,271.50. It also scored its first weekly gain in the last seven weeks.

At Friday's close, the S&P 500's 200-day moving average was around 1,259. If the level holds, it could be a springboard for stocks to rally.

"We seemed to have bounced off that level of concern that people were watching," said David Joy, chief market strategist at Ameriprise Financial, where he helps oversee $571 billion in assets. "At least for now, that is a little bit of evidence that these problems are solvable and markets could move higher."

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The Nasdaq, which often leads market moves, has not fared so well, and that is a worry to investors. It has closed below its 200-day moving average and kept falling on Friday when other indexes stabilized. It ended the week down 1 percent. From its 2011 closing high on April 29, the Nasdaq has tumbled nearly 9 percent -- getting close to a correction.

Bond markets remain anxious about a Greek default.

Most economists are overwhelmingly skeptical that Greece can ever repay its mountain of debt, which has reached 340 billion euros -- or 150 percent of the country's annual economic output.

Reuters' calculations using 5-year credit default swap prices from Markit show an 81 percent probability of Greece eventually defaulting, based on a 40 percent recovery rate.

SOME SAY IT'S TIME TO BUY

But for now, it seems stock investors are sanguine. They believe the European Union will rescue Greece without major disruption to markets and are using the drop in equity prices as a buying opportunity.

Bob Doll, chief equity strategist at BlackRock, says he has been using the pullback to reduce his underweight in cyclical stocks such as a Alcoa Inc <AA.N> , Applied Materials <AMAT.O>, and International Paper <IP.N>.

He has also been cutting his overweight in defensive areas such as healthcare, trimming positions in stocks like United Health <UNH.N> and Aetna <AET.N>.

Doll believes the S&P 500 will rally to 1,350 by the end of the year.

"We're going to find Band-Aids and we're going to muddle through these credit problems," Doll said. "The consequences of not following that route could be pretty dire, and I think the interested vested parties are going to step up."

BlackRock is one of the world's largest money managers with $1.56 trillion in equity assets under management. Doll is also lead portfolio manager of BlackRock's Large Cap Series Funds and advises on $317 billion that is actively managed.

TUNING IN TO THE FED

A slew of data showing the United States is on the verge of a slowdown has already done its damage to the market. After the heavy selling of the past several weeks, it seems investors are taking a wait-and-see approach -- for now.

Joy is waiting until after the summer before making big moves.

"There is so much uncertainty that it is probably not wise to make big long bets, but I think that opportunity may well arise toward Labor Day," he said.

In the meantime, any sign that fears may have been overblown could spur a rally. The final reading on U.S. gross domestic product for the first quarter is forecast to come in at an annualized growth rate of 1.9 percent -- slightly higher than the first two estimates. But investors will be on the lookout for a surprise.

"People are not expecting a lot from GDP so should it come a little better than expected, you could see a pretty decent rally," said King Lip, chief investment officer of Baker Avenue Asset Management in San Francisco.

Some analysts attribute much of the market's turmoil to the end of the Federal Reserve's asset-purchase program, known as quantitative easing, or QE2. That will come to a close at the end of the month.

Investors will be looking to Chairman Ben Bernanke to reassure markets after the Fed's two-day meeting ends on Wednesday.

"What investors are really looking for is not a QE3 but a QE2.5, where (the Fed) continues to reinvest the coupons they get from the bonds they purchased," Lip said. "If that's the case, investors will look well on that."

"If the economy is slowing as much as people are thinking, should there be more risk to second-quarter earnings? That's a real question we have to ask," Doll said. "There is risk of complacency -- no question."

(Reporting by Edward Krudy; Additional reporting by Angela Moon and Rodrigo Campos; Editing by Jan Paschal)