Watching Wall Street in the Weeks Ahead

As the credit crunch continues and recession fears mount, what's next? A mix of data reports, earnings releases, and market developments could provide clues

The threat of a recession is "as high as it's been since the last recession." That's the reaction of one economist, Keith Hembre of First American Funds, to the Sept. 7 jobs report.

Add that troubling employment data to the steep decline in housing, the rise in mortgage defaults, the crisis on the credit markets, and concern about other key economic measures, and Wall Street is worried.

Amid all this uncertainty, there are places investors can look in the next week or so for clues about our economic future.

First, Listen to the Fed

The Federal Reserve meets Sept. 18 to decide whether to cut interest rates—its strongest tool for speeding up the economy. So far, Fed Chairman Ben Bernanke has offered few clues about the Fed's direction (, 9/10/07). Policymakers have made clear that while they're ready to cut rates to help the broader economy, they won't intervene just to save investors from their bets on subprime mortgages or other risky assets.

"They've been reluctant to pull that lever," says Douglas Peta, market strategist at J. & W. Seligman. However, the new jobs data should push policymakers "off the fence" toward a significant move on Sept. 18.

If that's true, expect to hear a different tone from Fed governors in a series of speeches next week. No fewer than four policymakers speak on Sept. 10 and Bernanke steps up to the podium in Berlin on Sept. 11.

"The Fed is very big on communication," says Brian Gendreau, investment strategist at ING Investment Management (ING). "They don't like to surprise the market," he says. If a cut is coming, "they're going to start paving the way."

Second, Watch the Credit Markets

Other than a steep drop on Sept. 7, stock markets have stabilized somewhat since wild times in late July and early August. But credit markets still look bad. The problems began when defaults rose on subprime mortgages, affecting widely held mortgage-backed assets. But disruptions have spread to other areas of the credit markets as investors shun riskier debt.

To keep credit markets moving, the Federal Reserve took several steps, short of an interest rate cut, to flood banks with liquidity. But Hembre says the Fed's measures have been "completely unsuccessful." Credit markets, particularly the crucial commercial paper market, still look terrible, he says. Commercial paper is important because it provides companies with short-term funding. "That's really the working capital of Corporate America," Hembre says. If commercial paper markets don't recover soon, expect the trouble to deepen.

Third, Wait for More Data

The Sept. 7 employment report surprised Wall Street with a decline in August nonfarm payrolls of 4,000, the first decline in four years. Also worrisome, payroll numbers for June and July were revised sharply lower.

For Peta, the data "showed a way for the disruption in the credit markets to spread into the broader economy." If Americans start to lose their jobs, they could start cutting back on their spending. Consumer spending is about 70% of the total economy.

Despite the cries of alarm, the jobs data isn't definitive proof of a slowdown or recession. In fact, it raised more questions. "This strikes me as a little odd," Gendreau says of the report, because it came after other August data suggesting the economy was holding up well. Much of the payroll decline was the fault of local government, which puzzles economists.

"Next week we're either going to get numbers that confirm or contradict what we saw in the labor report," Gendreau says.

Retail sales figures on Sept. 14 may show the trend in consumer spending. "If that holds up, then businesses are going to have to start hiring again," says Peter Morici, a professor at the University of Maryland School of Business and former chief economist at the U.S. International Trade Commission.

Also coming soon are consumer confidence numbers on Sept. 11, mortgage application figures on Sept. 12, and initial jobless claims data on Sept. 13. On Sept. 14, data on export and import prices and industrial production are reported.

Look for the most recent data, Hembre says. The credit crisis is a relatively recent development and has only begun to show its effects. Therefore, data on industrial product or retail sales in August might not predict results for September.

Finally, Wait for More Shoes to Drop

In only a few weeks, the credit crisis has hit nearly every corner of the world. The financial instruments affected, especially mortgage-backed assets, are complex, hard to value, and widely owned. That's why, weeks after the crisis began, few have a handle on its true impact. European hedge funds, Asian banks, and Wall Street brokers have all reported losses.

"I'm watching for every data point and every piece of information we get," Peta says. Wait for more embarrassing press releases from some of the world's savviest financial institutions. More news should get investors closer to understanding the size and severity of the problem with toxic debt.

A key moment will be the third week of September, when four of Wall Street's biggest investment banks report earnings. Lehman Brothers Holdings (LEH) goes first on Sept. 18, then Morgan Stanley (MS) on Sept. 19, followed by Goldman Sachs Group (GS) and Bear Stearns (BSC) on Sept. 20.

Analysts will be pressing the big banks, which are usually vague and evasive about their holdings, for a full damage assessment.

Unfortunately, a fuller picture of the financial sector will have to wait until mid-October. That's when hundreds of insurance companies, banks, and asset managers will report on their third-quarter results.

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