Fear of recession to cloud U.S. stocks

NEW YORK (Reuters) - Fear of recession, stoked by rising unemployment and quickening inflation, will weigh on the stock market next week as investors look for clues from Federal Reserve Chairman Ben Bernanke about how he will address a deteriorating U.S. economy.

With a growing body of data pointing to a bigger economic downturn than previously expected and oil prices passing $100 a barrel investors will scour a speech by Bernanke on Thursday for his view on interest rates.

U.S. stocks tumbled on Friday on a Labor Department report that outlined weak job growth and rising unemployment in December. The Dow Jones industrial average is off 3.5 percent so far in 2008, its worst three-day start of a year since 1932 during the Depression.

Following the Labor Department report, Michael Strauss, chief economist at Commonfund, said he sees a best-case scenario for economic growth of 1 percent to 1-1/2 percent growth in the fourth quarter and less than that in the first quarter.

"The risk is that it's worse than that," said Strauss, whose Wilton, Connecticut-based fund has more than $40 billion under management. "This is at a minimum a growth recession and it could be a test of the real McCoy, if the Fed stays asleep at the switch."

Critics have slammed the Fed for being slow to address a credit crunch and decline in U.S. housing prices. Strauss said the Fed should cut interest rates before its next scheduled policy-setting meeting on January 29-30. Such a move would be unusual.

"The next couple of weeks are going to be very, very interesting here. And it's possible that the Fed is going to have to deal with some very difficult decisions," he said.

Bernanke is scheduled to speak in Washington on Thursday about financial markets, the economic outlook and monetary policy.

On Friday the Dow .DJI fell 256.54 points, or 1.96 percent, to 12,800.18. The benchmark Standard & Poor's 500 Index .SPX declined 35.53 points, or 2.46 percent, to 1,411.63. The Nasdaq Composite Index .IXIC tumbled 98.03 points, or 3.77 percent, at 2,504.65, and is now off more than 10 percent from its 52-week closing high set on October 31.

The rare gainers on Friday were electric utilities, drug makers, food and other products seen as essential to daily life -- a sign investors expect hard economic times ahead.

For the week, the Dow fell 4.23 percent, the S&P 500 was off 4.52 percent and the Nasdaq declined 6.35 percent.

There is little economic data or company results scheduled for release next week. Alcoa Inc's (AA.N) earnings report after the bell on Wednesday marks the traditional start of quarterly earnings. The only other company in the S&P 500 to report next week is KB Home (KBH.N) on Tuesday.

Investors will watch November pending home sales data on Tuesday, expected to show a 0.5 percent decline. A consumer credit report on Wednesday, also for November, will be watched for possible further credit tightening, which could cut into consumer spending.

The weakening U.S. economy has hit the financial sector hard, making it a harbinger for the overall stock market.

"Next week, as investors, we need to keep an eye on whether there's going to be continued deterioration in the financial sector," said Bucky Hellwig, senior vice president at Morgan Asset Management, in Birmingham, Alabama.

"We're not going to get a meaningful increase in the stock market until there is stabilization in the financial sector," Hellwig said.

The Standard & Poor's Financial Index .GSPF fell 2.86 percent on Friday, and is down more than 25 percent since the start of 2007. The sector, the largest in the broad S&P 500 index, was the hardest hit last year.

The job market will come into focus on Thursday when investors get a weekly reading of initial jobless claims. Analysts expect 340,000 claims; more than 400,000 could suggest the economy has fallen into recession.

On Friday import prices for December, expected to rise 0.2 percent, will be watched to see if inflation is quickening.

Oil and gold could also cause concern. Traders pushed oil to a record high of $100.09 a barrel last week although U.S. crude CLc1 retreated on Friday, settling at $97.91 a barrel. Spot gold XAU= set a lifetime high of $869.05 last week.

"The market is going to be taking a lot of cues from how oil prices do, and to some extent how gold prices do as well," said Rick Meckler, president of LibertyView Capital Management in Jersey City, New Jersey. The firm manages about $2.5 billion in assets.

(Additional reporting by Jennifer Coogan; Editing by Leslie Adler)