Fed, subprime jitters on tap

NEW YORK (Reuters) - One of Wall Street's oldest maxims will be put to the test next week: markets don't hit bottom on a Friday.

Stocks closed out their worst week in more than three months on fears that trouble at two Bear Stearns hedge funds may signal bigger problems ahead for credit markets.

Whether investors worry through the weekend and remain in a selling mood on Monday remains to be seen after the main stock indexes all fell by more than 1 percent Friday.

The week ahead brings no shortage of other events to test investors' nerves, with the foremost being a two-day Federal Reserve meeting on interest rates. Data on inflation and home sales are also on the slate.

For the stock market, a rise in bond yields has stalled a long-running rally. Some are worried that two troubled hedge funds managed by Bear Stearns Cos. Inc. BSC.N may only be the tip of the iceberg.

"I'm not sure this is the only mispriced device that has been created," said Marc Heilweil, president of Spectrum Advisory Services Inc. in Atlanta.

The hedge funds held subprime mortgages, a risky segment of the credit market that has been pummeled by rising defaults. Subprime borrowers are less creditworthy than other borrowers.

Heilweil, who manages about $390 million, said he has been using put options and inverse exchange-traded funds in client portfolios to get some downside protection. Those instruments increase in value when the market declines.

For the week, the Dow Jones industrial average .DJI fell 2.0 percent, the Standard & Poor's 500 index .SPX declined 2.0 percent and the Nasdaq Composite Index .IXIC retreated 1.4 percent.

SUBPRIME CONTAGION A WORRY

"People are concerned that this is a contagion that could spread elsewhere," said Stephen Massocca, co-chief executive at San Francisco-based investment bank Pacific Growth Equities.

Referring to Friday's sharp drop, he said it was a case of "Sell first, ask questions later."

Assuming no more major hedge fund problems surface, investors will be back to Fed-watching in the next week.

"Over the past 18 months, the market has really focused on the Fed and what the Fed says about the economy," said Brian Gendreau, investment strategist at ING Investment Management in New York.

The Fed has held the target for overnight interest rates steady at 5.25 percent since last June. When the two-day meeting ends on Thursday, only minor changes are expected in the Fed's official statement.

"What's been troubling the Dow is bond yields going up," Gendreau added.

The yield on the benchmark 10-year Treasury note has been approaching the 5.25 percent level. Higher interest rates lead to higher borrowing costs that can slow the economy.

HOME SALES, DURABLE GOODS AND GDP

The week's economic data includes existing home sales on Monday and new home sales on Tuesday.

A month ago, an eye-popping 16 percent rise in new home sales for April relieved some concerns about the state of the housing sector. For May, economists polled by Reuters expect new home sales to come in at an annual rate of 925,000 units, which would be a decline from the 981,000 rate in April.

According to the median forecast in a Reuters poll, the pace of existing home sales is seen falling slightly to a 5.98 million annual unit rate after 5.99 million in April.

On Tuesday, The Conference Board, a private research firm, reports on its survey of consumer attitudes in June. The closely-watched index of consumer sentiment is expected to decline to 105.5 from 108.0 in May.

On Wednesday, the Commerce Department reports on durable goods orders for May. The consensus is that orders for long-lasting manufactured goods fell 1.0 percent after an 0.8 percent rise in April.

Thursday brings still another revision to first-quarter gross domestic product. Economists expect the annual growth rate of the economy to be adjusted upward to 0.8 percent from the previously reported 0.6 percent.

A report on personal income is due from the Commerce Department on Friday. Economists estimate that incomes of individuals rose 0.6 percent in May after a drop of 0.1 percent in April. That data also includes an inflation gauge that is closely studied by Wall Street.

Friday also brings an update to the Reuters/University of Michigan Survey of Consumers.

Earnings are few and far between next week. On Tuesday, Nike Inc. (NKE.N), the world's largest maker of athletic shoes and clothing, reports quarterly results, as does grocery chain Kroger Co. (KR.N)

Quarterly reports will also be coming from home builders Lennar Corp. (LEN.N) and KB Home (KBH.N). Lennar is due on Tuesday and KB Home reports on Thursday.

(Wall St Week Ahead runs every week. Questions or comments on this column can be e-mailed to cal.mankowski(at)reuters.com)

(Additional reporting by Ellis Mnyandu)