NEW YORK (Reuters) – The euro zone will once again serve as the source of Wall Street's angst, as investors look to a summit of the region's political leaders for decisive solutions for the ballooning debt crisis.
Stocks posted their best week in more than two years this week, driven by central bank efforts to provide cheaper dollar loans to struggling European banks.
In addition, the new head of the European Central Bank said on Thursday the ECB stands ready to act more aggressively to fight Europe's debt crisis if political leaders agree to much tighter budget controls at the December 9 summit.
But Wall Street investors can be forgiven for feeling like they've been in this position before. Markets seesawed throughout the fall, guided by prevailing sentiment out of Europe.
"Next week it will be all focused on the upcoming Friday summit. But don't forget this is the fifteenth summit we've had now during the euro zone crisis, and every one the market gets excited, gets excited and then boom - it gets disappointed," said Ken Polcari, managing director at ICAP Equities in New York.
Until now, the ECB has resisted prodding from markets and world leaders to step in as the lender of last resort. European credit market yields have soared in recent weeks on concerns that the euro zone could break up or one or more countries would default on their debt.
French President Nicolas Sarkozy said he and German Chancellor Angela Merkel would meet next Monday to outline joint proposals for the summit.
Investor optimism over apparent progress by euro zone leaders towards taming their debt problems helped propel the S&P 500 (.SPX)(.INX) 7.4 percent higher for the week, its best weekly performance since March 2009. The best performers in the last week were companies with more international sales, according to Bespoke Investment Group, an investment adviser in Harrison, New York.
While volatility remains high as markets remain susceptible to any negative headlines coming out of the euro zone, investors appear satisfied for the time being that the region's leaders will remain on track in tackling the crisis.
THEIR LEHMAN MOMENT
"We've seen some policy changes which suggest they are finally beginning to understand that they've got a problem," said Phil Orlando, chief equity market strategist at Federated Investors in New York.
"They are finally recognizing that this is their Lehman moment, and they have got to do the same sort of things that we did back in the 2007 to 2009 period."
With markets swings closely tied to sentiment about the progress made in the euro zone, investors have been forced to weigh the region's fiscal stability with U.S. stocks that are seen as cheap by many analysts.
Recent corporate outlooks and analyst projections have been painting a less rosy picture, with estimates for fourth-quarter S&P earnings growth tumbling over the past two months as well as a near-record high ratio of negative corporate preannouncements to positive ones, according to Thomson Reuters Proprietary Research.
Even if European leaders continue on a path that investors have cheered, the difficulty in putting plans in place may throw cold water on investor optimism. Borrowing costs in major nations such as Italy and Spain remain at levels considered unsustainable in Europe's slow-growth economy.
"I don't know that the market just rallies straight through into the end of the year because whatever solution they come up with will be hard to implement," said Nicholas Colas, chief market strategist at the ConvergEx Group in New York.
"It will be politically hard, it will be economically hard and you will be facing the very real threat of a recession -- a pretty deep recession in Europe in the first half of next year -- because of all the uncertainty that is being created right now."
The U.S. economic calendar for next week is light, with the ISM services report, weekly initial jobless claims and the trade balance among the highlights.
(Additional reporting by Ryan Vlastelica; Editing by Kenneth Barry)
