Coping With Europe's Chaos

(Reuters) Wall Street may find it hard to rally this week as Greece's new and untested coalition begins the process of ratifying a 130 billion-euro lifeline and the fate of Italy's government hangs by a thread.

Greek Prime Minister George Papandreou and conservative opposition leader Antonis Samaras agreed on Sunday to form a new coalition government to approve the Eurozone bailout deal. On Wall Street, the welcome was cautious.

We come back to whether this deal is sufficient to solve the problem, said Jerry Webman, chief economist and senior investment officer with Oppenheimer Funds in New York. I think it is a reasonable step in the right direction, but in my opinion the answer is no.

With the immediate crisis in Greece seemingly under control for now, the next flash point for markets could be Italy, where premier Silvio Berlusconi's fate rested on a group of party rebels threatening to pull the rug from under his government this week.

The renewed flare-up in Europe's debt crisis, which started just days after investors thought a deal had been reached at an EU summit in Brussels, has again stressed Europe's credit markets and drove the first weekly fall in U.S. equities in a month.

Investors fear that a disorderly default of an EU sovereign would trigger losses in creditor banks that could ricochet around the global financial system much in the same way the bankruptcy of Lehman brothers hit markets in 2008.

Italian bonds sold off again on Friday to push their yield to a record euro-era high above 6.4 percent. The spread over German bunds, reflecting the higher risk premium investors place on Italy, also hit a record above 4.6 percentage points.

But although stocks fell last week, the S&P 500 held the top end of its recent trading range at around 1,250. That has been seen as a sign of resilience by investors who have become emboldened by better-than-expected U.S. data and corporate earnings.

The formation of a new government in Greece will be another support under the market and may even spur some risk-taking when markets open -- but it is not expected to last.

It's the best-case scenario and may spark a brief relief rally, said Alan Ruskin, head of G10 currency strategy at Deutsche bank in New York. But it won't last and we will soon go back to focusing on Italy.

Friday's U.S. monthly jobs report suggested some improvement in October, even though the headline payroll numbers appeared weaker than expected.

Non-farm payrolls rose a tepid 80,000 in October, below economists' expectations. But employers added 102,000 more jobs than previously estimated in August and September.

And the U.S. unemployment rate slipped to 9 percent. It had been stuck at 9.1 percent for three straight months.

What I'm seeing at the moment is that investors are getting more reassured with the picture that the U.S. may actually do OK despite the troubles in Europe, said Natalie Trunow, chief investment officer of equities at Calvert Investment Management in Bethesda, Maryland, which manages about $13 billion.

The more recent data points on the U.S. economy and earnings profiles are supporting that assertion, she said.

The benchmark Standard & Poor's 500 index <.SPX> posted an 11 percent gain for October -- its best monthly percentage rise since December 1991.

With results in from some 433 of the S&P 500 companies, 70 percent have beaten forecasts on third-quarter earnings, defying views that growth would be hit by the problems in Europe and a slower economy in China.

Analysts have said earnings growth has helped to support the market and has taken some of the focus away from Europe, even if just momentarily.

More reports are expected this week, including those of several retailers like Macy's, whose results could shed some light on how the holiday shopping season may go.

EUROPE STILL CAUSE FOR VOLATILITY

Still, strategists see plenty of volatility ahead, making any big moves hard for short-term investors.

The CBOE Volatility Index fell 1.1 percent to close at 30.16 on Friday, but is well above levels from just last summer. It was trading near 20 in early August.

For the week, the VIX rose 22.9 percent following wide market swings in four of five trading sessions.

By taking a longer-term approach, though, some investors have been able to see the current situation as a buying opportunity, analysts said.

Stock valuations are cheap, so if earnings hold up, investors are likely to be better positioned in stocks than in bonds or cash, they said.

The S&P 500 forward price-to-earnings ratio is now at 12, its lowest in years.

Savvy investors are using the dips to put some money to work, but this is a very difficult market if you're a short-term trader, said Fred Dickson, chief market strategist at The Davidson Cos. in Lake Oswego, Oregon.

Among this week's key economic indicators are the U.S. international trade deficit for September, due on Thursday, and on Friday, the preliminary November reading on consumer sentiment from the Reuters/University of Michigan surveys.

(Reporting by Caroline Valetkevitch and Edward Krudy; Additional reporting by Ryan Vlastelica, Doris Frankel, Richard Leong, and Steven C. Johnson; Editing by Jan Paschal, Maureen Bavdek and Gunna Dickson)