Wall Street Week Ahead: Markets Edgy on Debt-Talk Stalemate

Much of the United States may be frying in near-record temperatures, but Wall Street has been feeling the heat for months. Wrangling over the debt ceiling has kept markets on edge, and investors are still waiting for a breakthrough that leads to a deal to avoid a devastating default.

Investors have viewed as extremely unlikely the possibility of a U.S. default if the federal government does not agree to raise the debt ceiling. But the odds are growing, and Congress and the White House remained at odds just a few hours before Asian markets opened on Monday.

"Unless during the course of the day there is a specific, concrete proposal that placates the market before Asian markets open, the worst-case scenario is that the markets just sell off -- sell off dramatically," said Quincy Krosby, market strategist at Prudential Financial in Newark, N.J.

White House officials and Republican leaders scrambled on Sunday to reassure global markets the United States would avert a debt default, but the two sides gave no sign they were moving closer to a deal.

White House Chief of Staff Bill Daley warned that there would be a "few stressful days" ahead for financial markets, with the deadline to lift the $14.3 trillion U.S. borrowing limit now only nine days away.

"To some degree the outcome of there being no deal has been priced in, but the discounting is not fully in the market and this is adding to uncertainty that has already been coupled with the events in Europe and expectations that growth was already going to be weak," Krosby said.

Wall Street is set to close its worst three months in a year as July draws to an end this week after a roller-coaster ride for markets.

With euro zone leaders having reached a deal for yet another bailout for debt-laden Greece, investors will be free to chew over the rancor in Washington with even more attention.

In addition, the corporate earnings season suggests other risks could dog the market. Despite generally good results so far, there have been some worrisome signs.

The S&P 500 rallied 6 percent in the run-up to reporting season, but earnings misses from big industrial names like Rockwell Collins and Caterpillar Inc weighed on the Dow and S&P 500 on Friday.

Earlier in the week several big consumer names such as Whirlpool and Pepsi warned about sluggishness in developed markets, sending their shares sharply lower.

"The market still has a high degree of skepticism in it," said Nick Kalivas, an analyst at MF Global in Chicago, summing up the earnings season so far.

Kalivas said he will be closely following earnings from sector and economic bellwethers this week. Those include the package delivery company UPS, chipmaker Texas Instruments, and online retailer Amazon.

Around 30 percent of the S&P 500's $12.3 trillion market cap have reported earnings so far. They have outpaced consensus estimates by 3.8 percent, and only 7 percent have missed estimates, according to data from Morgan Stanley.

But share prices of those that have fallen short of estimates have taken a severe beating. Given the fragile sentiment, a few more prominent misses could derail the market.

"The market is punishing these misses more than it is rewarding beats, an asymmetry we have been calling for and we forecast will continue," Morgan Stanley's U.S. equity strategist Adam Parker wrote in a note to clients.

"Our view remains that first half of the year numbers are achievable, but the second half of the year looks challenged," he said.

This week is also a big week for economic data. Fears of a slowdown in the economy have been a large driver of market volatility over the last few months, and the coming releases will be parsed very closely.

They include early regional manufacturing data from Chicago and New York, a reading of consumer sentiment, and a first reading of U.S. growth for the second quarter, expected to show the economy grew just 1.9 percent in the period.

Bob Doll, chief equity strategist at BlackRock, one of the world's largest fund managers with around $1.6 trillion of equities under management, said last week that the U.S. economy is at a critical juncture.

Doll points out that since 1960 every time year-on-year growth has fallen under 2 percent the U.S. economy has gone into recession.

"Our bottom line view is that investors should maintain a reasonably constructive bias toward risk assets, but should also be prepared to scale back exposure if evidence of economic growth acceleration does not materialize," said Doll.

And many believe economic activity will be depressed if a failure to raise the debt ceiling interrupts key government services such as social security and Medicare.

The uncertainty is sure to stress markets further, and fund managers hitting the beach in August may find themselves fiddling with their BlackBerrys more than the little umbrella in their cocktails.

"I need a vacation, man. After all the stuff that's happened in the last three months I'm pretty much shot, I'm getting weird, even my 6-year-old looks at me," said one New Jersey-based fund manager, who was packing his bags for a destination in the Caribbean as temperatures topped 100 degrees Fahrenheit in New York City.