The next two weeks will be consequential in determining the next major move in the stock market. The meat of earnings season begins on Tuesday night when Microsoft (MSFT) reports, followed by hundreds of other reports in all sectors of the market.
On Wednesday, February 1, the Federal Open Market Committee will announce its interest rate decision at 2 pm ET. It is now widely expected that the Fed will raise rates by just 0.25%, but how many more hikes will there be, and will there be a pause in the Fed's battle against inflation?
So far the earnings season has been lackluster, with the exception of Netflix (NFLX) , which helped to trigger a sizable rally on Friday. Sentiment improved nicely as the market celebrated a vision of a less hawkish Fed and some signs of corporate earnings growth.
Most of the earnings so far have been in the financial sector and have not been very strong, but the real test will come when growth stocks start to report this week.
Mike Wilson of Morgan Stanley notes that economic growth and earnings are weakening, and the optimism about a less hawkish Fed is misplaced. Wilson told Bloomberg: "The question is when will equity indices price the current weakness in the leading data and the eventual weakness in the hard data? We think it's this calendar quarter."
If Wilson is correct, we should start seeing some market reactions this week as earnings reports roll out.
The market has been very sanguine about the potential for slowing growth and a recession. The view is that the Fed can deal with that very quickly and easily by pivoting to a more dovish approach. After the very aggressive Fed hikes, there is plenty of room for the Fed to back off if the economy really starts to slow.
There is quite a bit of optimism that the Fed can navigate the balance between the war on inflation and strength in the economy. Fed speakers warn that major obstacles are ahead, but the bulls ignore that skepticism. The view is that the Fed really isn't that pessimistic but has to send that message to prevent the market from running away to the upside.
Technically the indexes are in a trading range. The S&P 500 is testing its 200-day simple moving average while the Russell 2000 (IWM) has enjoyed good relative strength due largely to the January 'effect' when badly hit small-caps bounce back.
There is significant overhead resistance on the charts, and it will take some very euphoric responses to earnings to overcome it.
The battle lines are drawn this week, and we will have some solid clues about what lies ahead when it is over.
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