By Jeremy Gaunt, European Investment Correspondent
LONDON, Jan 15 (Reuters) - Investors head into next week having had a small taste of what lies ahead this year, monetary tightening in a major economy -- and, frankly, they didn't like it.
They also had to deal with a disappointing start to an earnings season that is about to heat up, with big bank results to the fore. Again, they didn't like it.
The result has been that while the risk-asset rally that began in March last year has not been reversed, it has stumbled. World stocks as measured by MSCI were set to end the week flat while the dollar rose on Friday.
The week ahead could thus be a watershed, testing the sustainability of what have been entrenched investment patterns with more earnings, Chinese growth data and continuing worries about sovereign debt. One of the biggest drivers will almost certainly be the U.S. earnings season, which has got off to a rocky start.
Alcoa disappointed and there were profit warnings from Chevron and, in Europe, Societe Generale. JPMorgan, the second-largest U.S. bank by assets, had a better-than-expected profit, but put investors off with rising losses on mortgages and commercial loans.
Ahead lie IBM, General Electric, Google and a host of major banks, including Citigroup, Bank of America, Morgan Stanley, Goldman Sachs and Wells Fargo.
In purely numerical terms, most earnings are supposed to be spectacular because of a year-on-year impact. But investors will be burrowing deep for signs of real improvement.
"Markets will want to see evidence of strength in the private sector demand, because its important the economy stand on its feet after the public fiscal stimulus starts to fade which will probably happen around mid-year," said Geoff Lewis, head of investment services at JP Morgan Asset Management in Hong Kong.
That, indeed, is the theme of the year so far: How much real earnings and economic growth is out there that is not simply a reflection of government pump priming and loose monetary policy from central banks.
Some argue not much. HSBC economists reckon the recovery in developed economies is exceedingly fragile and that hopes for a return to decent growth and other modest changes in the economic climate are "too good to be true".
HOT AND COLD
Just how jittery investors are about this can be seen from the risk aversion that hit global markets after China effectively tightened monetary policy.
China's was a small move -- the central bank raised commercial banks' reserve requirements by 0.5 percentage points -- but it underlined investor concern about the eventual withdrawal of stimulus and what that would mean to growth.
China is particularly important because with developed economies struggling, its role as an engine of world growth has grown. It is being looked upon by many to lead the world out of its problems in much the same way as the United States traditionally has.
With that in mind, the coming week's fourth-quarter GDP report on Thursday will be closely watched. China is expected to have returned to double-digit growth in the quarter, with a Reuters poll predicting 10.9 percent growth versus 8.9 percent in the third quarter.
Reaction to report will actually exemplify a dilemma on a global basis, whether to want growth or not.
If Chinese GDP is less than expected, markets would fear that world growth recovery is stalling. If, on the other hand, it were to be strong it could lead Beijing to quicken its pace in exiting its crisis-mode policies.
"From an economic perspective, China is likely to experience a near `Goldilocks' environment of solid growth and relatively low inflation in Q1 2010. As growth continues to accelerate, though, there is the increasing likelihood that nascent inflationary pressures will become more robust," investment house RCM said in a note.
GREEK FIRE
The third major factor facing investors in the coming week is the continuing worry about sovereign risk, led by, but by no means exclusively, Greece.
The cost of insuring Greek government debt jumped during the week on fears about its huge debt and even the data being produced to calculate it.
Iceland too saw a rise in the cost of debt insurance and others economies are under pressure over their finances.
Indeed, the World Economic Forum put deteriorating government finances pushing economies into full-fledged debt crises at the top of a list of threats facing the world in 2010.
"Governments, in trying to stimulate their economies, in fighting the recession, are (building) unprecedented levels of debt and therefore there is a rising risk of sovereign defaults," said John Drzik, chief executive of management consultancy Oliver Wyman in a WEF risk report.
Ratings agency Moody's also saw the debt risk spreading. In a report, it said that tough budgetary conditions, including lower tax revenues, were likely to hurt regional and local government debt in a range of countries including Spain, Greece, Mexico and Russia. (Additional reporting by Sujata Rao; Editing by Andy Bruce)