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Wall Street Week Ahead: Rally's stamina hangs on Europe

By Angela Moon

NEW YORK (Reuters) - Investors celebrated U.S. stocks' best week in 2012 on Friday, but a cloud hangs over Wall Street, and it's what may happen in debt-plagued Europe this weekend.

Spain is expected to ask the euro zone for help with recapitalizing its banks, a deal that could ease markets' most immediate concern about the region's financial crisis.

The euro zone's deputy finance ministers will hold a conference call on Saturday to discuss the request, five senior European Union and German officials told Reuters on Friday.

At a minimum under adverse scenarios, several of Spain's banks would need about 40 billion euros or $50 billion of capital to meet core Tier 1 requirements under the Basel III standards, the International Monetary Fund said in a report released on Friday night.

"All eyes are on what will happen with Spanish banks over the weekend. The level of uncertainty is high and the fear in the market has certainly elevated," said Amy Wu, equity derivatives strategist at RBC Capital Markets in New York.

Wu noted that the volatility skew in options, which had decreased gradually throughout the week, has moved back up. Volatility skew, which is affected by sentiment and the supply-demand relationship, measures the premium for downside puts compared to upside calls.

Christine Lagarde, managing director of the IMF, said it is urgent that Europe fix its banks and create a system for more unified bank supervision with a single deposit insurance fund.

"Let me be clear: The heart of European bank repair lies in Europe. That means more Europe, not less," she said, in prepared remarks released Friday night. The speech was set for delivery before a Leaders Dialogue in New York.

Investors and U.S. policymakers worry Europe's political and financial woes will threaten the fragile U.S. economic recovery.

Besides Spain's weakened banks, parliamentary elections are scheduled in Greece on June 17. The results could decide whether the country continues austerity measures it agreed to as part of an international bailout or whether Greece leaves the euro zone.

BAD NEWS PRICED IN

Wall Street has been hit hard by other concerns, including signs of a slowdown in U.S. growth and shrinking demand in China, the world's No. 2 economy.

But some market participants said investors have priced in bad news out of the euro zone.

"I don't think a lot more downside is in the cards at this point" unless there is another shock, said Natalie Trunow, chief investment officer of equities at Calvert Investment Management in Bethesda, Maryland, whose firm manages about $13 billion in assets.

The broad S&P 500 index fell 6.3 percent in May, its largest percentage drop since September. The Dow's 6.2 percent drop and Nasdaq's 7.2 percent loss in May were their largest monthly declines in two years.
On June 1 the S&P 500 ended below its 200-day moving average for the first time this year, but the index clawed its way back above the key level and rallied later in the week on hopes Europe would find solutions to its problems.

"The market has been basically expecting bad news since earlier this year, so we have been pretty well hedged to the downside. Now, it's the rally that is scaring people." Wu said.

"You don't want to be that person having to explain to your boss why you missed the rally."
For the week, the Dow advanced 3.6 percent, the S&P 500 rose 3.7 percent and the Nasdaq jumped about 4 percent - their best weekly percentage gains since December.

The U.S. economic calendar in the coming week includes data on the Producer Price Index and retail sales on Wednesday. Reports on the Consumer Price Index and initial weekly jobless claims are set for Thursday.
 Data on Friday includes the Empire State manufacturing index, U.S. industrial production and the preliminary reading for June on consumer sentiment from the Thomson Reuters/University of Michigan surveys.
(Wall St Week Ahead runs every Friday. Comments or questions on this column can be emailed to: angela.moon(at)thomsonreuters.com)

(Reporting By Angela Moon; Additional reporting by Caroline Valetkevitch; Editing by Kenneth Barry and Jan Paschal)