U.S. Stocks To Fall Further Next Week As Credit Woes Persist

NEW YORK (MarketWatch) -- U.S. stocks will continue to fall next week, in continuation of a sell-off that saw the Dow Jones Industrial Average experience its worst week in over four years, due to nervousness that the easy-money binge of the last few years has come to an end.

Another heavy week of earnings, including 99 reports from S&P 500 companies, capped by the all-important July employment report on Friday, also awaits investors.

But stocks will remain vulnerable to any new signs of distress from hedge funds hit by their exposure to bad U.S. home loans, as well as from credit markets, where Wall Street firms and corporations are finding it harder and harder to obtain financing.

"We're finishing up earnings season and the general tone has been positive," said Owen Fitzpatrick, head of the U.S. equities group at Deutsche Bank. "But it's been overwhelmed by the whole subprime and credit-market issues."

Stocks stumbled over the past week, with the Dow Jones Industrial Average losing 4.2% on the week after experiencing two successive sell-off sessions -- 312 points on Thursday, and 208 points on Friday.

That was the worst week for the Dow since March 2003, and it ended up leaving the blue-chip average down 1% for the month so far, just one week after it closed above 14,000 for the first time. The Dow still sits on a gain of 6.4% for the year.

The S&P 500 Index plunged 5% on the week and the Nasdaq Composite Index lost 4.6%.

"Now we have the weekend to put things in perspective and then see whether any more troubles emerge in the hedge fund world and in credit markets," Fitzpatrick added.

Next week, investors will sift through earnings from Dow components Verizon Communications Inc. on Monday, General Motors Corp. on Tuesday, Walt Disney Co. on Wednesday and Procter & Gamble Co. on Friday.

Away from the Dow, investors will await earnings from tech bellwether Sun Microsystems Inc. on Monday, as well as from Electronic Data Systems on Wednesday. Big telecom firms including Qwest Communications International , Citizens Communications and Alltel Corp. also report Wednesday.

Hedge-fund woes

What began in recent months with the collapse in the subprime-mortgage financial sector has led to a ripple effect devastating a number of hedge funds, including two that are part of Bear Stearns Cos.

Investors next will remain on the lookout for more hedge-fund troubles globally. One of the latest bouts of anxiety came Thursday with news that a second Australian hedge fund, this one partly owned by Dutch financial-services giant ABN Amro also has run into trouble because of its exposure to U.S. subprime mortgages.

There were also unsubstantiated market rumors about German and Japanese funds taking a hit from bad U.S. home loans.

"It would actually be surprising if there weren't hedge fund troubles after the recent surge in volatility and asset allocation swings," analysts at Action Economics wrote in a note.

Credit markets freeze

Increasingly investors are refusing to provide Wall Street firms with cheap money to finance leveraged buyouts, a key source of support for the stock market over the past few years.

Firms seeking to finance the leverage buy-outs of a majority of DaimlerChrysler AG's unit Chrysler and of General Motors Corp. unit Allison Transmission had to delay the deals this week as credit markets refused to provide them with the expected advantageous terms.

Investors will be keen to see whether there is any progress on either deal next week. In addition, some companies such as Dow component Home Depot Inc. may run into trouble when they try to raise money for already announced stock buy backs, according to John Atkins, corporate bond analyst at IdeaGlobal.

No fireworks in earnings so far

"Earnings are still coming out despite the market's troubles," said John Butters, analysat Thomson Financial. "We've seen decent earnings so far, but they're not spectacular by any means."

Second-quarter earnings growth expectations for S&P 500 companies have still improved to 5.8% in the latest week from 5.2% last week and 4.1% on July 1.

But companies reporting have so far beaten expectations by a slightly lower margin than in the recent past. Out of the 304 companies of the S&P 500 that have reported, 64% beat estimates compared with an average of 68% over the past eight quarters.

Among Dow components, Boeing Co. and Merck & Co. beat estimates by a wide margin last week, while Exxon Mobil Corp. disappointed. 3M Co. , AT&T Inc. and American Express just beat expectations by a slight margin.

Elsewhere, the biggest upbeat surprise came from Ford Motor Co. , which posted an increase in profits instead of a loss. But overall, the gains were offset by the poor showings at Exxon and at home builder DR Horton , Butters said.

Another 99 companies from the S&P 500 will report earnings next which, after which, 80% of the components of the index will have reported.

Employment report

Economic data has taken a back seat to the recent credit jitters.

On Friday, news that the U.S. economy rose 3.4% in the second quarter, was offset not only by the credit jitters, but also concerns that growth in the second half of the year will worsen, with consumers tired by weakness in housing.

But investors will still pay close attention to the July employment report on Friday, according to Fitzpatrick at Deutsche Bank.

"There are so many negatives out there, that any signs of weakening in employment would be bad," he said.

The theme that global growth is still supporting earnings for U.S. multinationals has been bypassed over the past week. "Everyone is being placed on the same boat.

"We might well soon see an impact from our slowdown onto global markets," Fitzpatrick commented. "The main story so far had been that U.S. housing weakness would stay contained, but we've had the evidence this week that it clearly isn't the case."

By Nick Godt