It's earnings versus Europe for stocks

A sign is shown at the entrance to the headquarters of Intel Corporation in Santa Clara, California February 2, 2010. Picture taken February 2, 2010.

NEW YORK (Reuters) - Stock investors will return to a tug of war between signs of domestic strength and overseas concerns next week as a batch of critical earnings reports look to add credence to the idea the economy is improving, while credit rating downgrades in Europe will keep that region's difficulties in view.

Bank stocks will probably once again be a primary focus, as not only will European issues call the group's profit outlook into question, but many key names report results.

Equities have recently undergone a decoupling with respect to Europe's sovereign debt crisis as signs of progress in the euro zone, along with improving U.S. data, have pushed Wall Street higher on improved growth prospects. Financials have been a beneficiary of that rising tide, with Bank of America up 22 percent since the start of the year.

So far this month, the S&P 500 .SPX is up 2.5 percent, while the Dow .DJI is up 1.7 percent and the Nasdaq is up 4.1 percent.

"We're going to see more volatility in the weeks ahead with tension between earnings and Europe," said Christopher Sheldon, the Boston-based director of investment strategy at BNY Mellon Wealth Management, which oversees $171 billion globally.

"We want to see Europe resolved, but there will continue to be ups and downs, and while earnings will continue to be relatively good, we do expect slowing compared with 2011."

However, the uncertainty about Europe returned in a big way on Friday after Standard & Poor's downgraded the ratings of several euro-zone countries, including Italy, after the market closed. Talk of the downgrades spurred a selloff that erased most of the gains for the week, when the S&P rose for four straight sessions.

A downgrade could exacerbate the area's difficulties and bring concerns about how they might affect U.S. banks profits back to the forefront.

Still, market participants looking for signs of strength don't have to look far. Data has been bullish lately, including Friday's consumer sentiment reading at an eight-month high that sharply exceeded what was anticipated.

"The prospect of a downgrade has been around for a while, so despite today's reaction, everyone was aware of the potential, and I don't think it will be as impactful, especially as corporate business trends remain strong," said Hank Herrmann, chief executive of Waddell & Reed Financial Inc in Overland Park, Kansas.

HINTS OF BETTER TIMES AHEAD

Earnings reports from numerous bellwethers could reinforce the growth story. Bank of America Corp (BAC.N), General Electric Co (GE.N), Intel Corp (INTC.O), Goldman Sachs Group Inc (GS.N) and Microsoft Corp (MSFT.O) are among the names set to report.

Early reads have supported the idea that better times lie ahead. JPMorgan Chase & Co (JPM.N) said the domestic economy was strengthening even as its profit fell 23 percent, while Alcoa Inc (AA.N) rallied earlier in the week after giving a bullish outlook for the aluminum sector.

"Banks will be an important part of the story, especially with Europe in the picture, and investors will also be looking at names like GE, which have global exposure, to see what insights can be gleaned from that," said Herrman, who helps oversee $90 billion in assets.

Next week, when markets will be closed on Monday because of the Martin Luther King holiday, will also see the release of the New York Fed's January manufacturing data, December readings on inflation from both the Producer Price Index and the Consumer Price Index, as well as December housing starts.

For the week, the Dow rose 0.5 percent while the S&P 500 gained 0.9 percent and the Nasdaq added 1.4 percent.