Traders to focus on bank earnings, looming across the board U.S. spending cuts

TORONTO - Investors will have plenty to chew on this week including earnings news from most of the big Canadian banks and the latest economic growth data for Canada.

But the week could very start out on a cautious tone as traders wonder if U.S. politicians can come up with an alternative to the sequestration, the name for an automatic series of across-the-board spending cuts set to take effect Mar. 1.

And the eurozone debt crisis could be back in focus depending on the outcome of an Italian election Sunday and Monday that is too close to call.

North American markets finished last week little changed after investor sentiment took a hit from another indication that the Fed is considering ending its current economic stimulus program involving bond purchases.

Minutes from the Fed's latest policy meeting showed that some policy-makers were worried that the bank’s US$85 billion in monthly bond purchases could eventually unsettle financial markets or cause the central bank to take losses.

The best bit of news this week could come from the big banks. Traders will take in quarterly earnings from Bank of Montreal (TSX:BMO), Royal Bank (TSX:RY), TD Bank (TSX:TD) and CIBC (TSX:CM).

"We may find results a little bit more subdued given the slowdown in the housing market," said Colin Cieszynski, market strategist at CMC Markets Canada, adding that investors expect dividend increases from all four banks, along with Scotiabank (TSX:BNS) which reports next week.

"Volumes have come down but housing prices haven’t come down much but certainly there’s a big risk out there that prices could come down. Clearly, they have huge exposure to the Canadian housing sector."

The Canadian Real Estate Association said last week that the number of homes sold in Canada last month was down 5.2 per cent from January 2012. The January national average sales price compiled by the industry group was $354,754, up two per cent from a year earlier.

Investors will look ahead to Friday, when a round of federal budget cuts known as the "sequester" will hit unless Congress and President Barack Obama can strike a deficit-reduction deal to avert them.

The cuts would total about US$85 billion and economists warn that they would take a bite out of U.S. economic growth. But many traders seemed resigned to the cuts going through.

"Yes we’re talking billions but in the context of the U.S. national product, they are manageable," said Patrick Blais, managing director and portfolio manager at Manulife Asset Management, adding it is expected the cuts would affect about one per cent of economic growth.

"That said, the market realizes that is something that needs to happen, there needs to be some deficit reduction. We would have preferred a bargain that would address the more significant issue of entitlements. This is directed less efficiently as discretionary items but it’s better to start addressing the issue than to push it down the road."

In Europe, the Italian elections could stoke renewed worries over Europe's debt crisis especially if there is a protracted period before a government is formed.

But Blais points out that what happens in Germany is key to the eurozone.

"With respect to the Italian elections, Europe lives by Germany and the fundamentals and the economic indicators in Germany are positive and we think the market will refocus on the German economy as the main driver for Europe," he said.

There was good news on that front at the end of last week after survey of German business optimism rose sharply, adding to evidence that the country will avoid a recession. Germany’s economic vitality is crucial for the beleaguered region, offsetting economic contraction in surrounding countries.

On the economic front, Statistics Canada is expected to report Friday that Canadian gross domestic product grew by 0.7 per cent in the fourth quarter. But it looks like growth started to flatten at the end of the year as the economy likely contracted by 0.1 per cent in December after rising 0.3 per cent in November.