When aluminum producer Alcoa (NYSE: AA) reports first-quarter results after the bell on Tuesday, April 10, earnings season will officially be underway. What happens to stocks for the next two to three weeks will almost exclusively be a function of what major companies have to say about current business trends. Few investors will have time to focus on anything else — but they should. Behind the scenes, a steady release of economic data — especially regarding consumer, business and investor sentiment — will dictate the trading mood well beyond the current earnings season.

We just got a clear read on how small businesses are feeling. The NFIB Small Business Optimism Index, which I focused on last month, was released on April 10. The news is sobering. After six straight monthly gains, the index fell in March, thanks to a pullback in nine of the 10 components that make up the index. And the analysts at NFIB deliver a real wake-up call after parsing the data:

“The mood of owners is subdued — they just can’t seem to shake off the uncertainties out there, and confidence that the management team in Washington can deal with the effectively is flagging. What we saw in March is painfully familiar — this was the same pattern of growth followed by months of decline from 2011. History appears to be repeating itself — and not in a good way.”

As I wrote a month ago, “this index actually spiked to 94 last January and February and then dropped back into the 80s. If you sold stocks in April after seeing the NFIB pullback in March 2011, then you would have avoided the heavy losses the market produced later that summer.”

The current reading of 92.5 isn’t a disaster but the trend needs to be watched. Here’s what else you should keep an eye on in coming weeks.

1. Mutual-fund inflows
One of the key factors behind the recent rally has been a decision by mutual fund and hedge fund managers to put their idle cash into play. For mutual fund managers, the move was a bit curious, as funds flowed out of domestic stock funds in the first quarter due to residual wariness by individual investors. That means mutual funds have used up much of their latent firepower, unless they get more money to put to work.

Will that happen? History is promising. After people send off their tax returns, oftentimes their next move is to replenish their retirement plans, so the second half of April and May are usually periods of net inflows to mutual funds. The key question: Will investors earmark those funds for equity funds and exchange-traded funds (ETFs) or bond mutual funds and ETFs?

You can track the weekly flows here. According to Lipper, bonds are getting most of the love right now, as many investors failed to be seduced by the market’s recent upturn.

2. Individual investor sentiment
There are some investors that remain quite bullish. According to the most recent weekly snapshot of investor sentiment from the American Association of Individual Investors (AAII), bulls outnumber bears by a four-to-three margin. That shouldn’t make you bullish, however, as investor sentiment actually tends to negatively correlate with future market direction. In fact, I would love to see this indicator turn starkly negative, which would be great for stocks, as I wrote about back in 2010.

Bulls really predominated this survey in early February of this year, casting more than 50% of the votes (while bears had just 20%). That bullish reading stands at just 38% (as of April 4), so we may be seeing a move towards a “stocks are hated” backdrop.

3. What about the banks?
Professional money managers often seek out the direction of banking stocks before making any buy or sell decisions. That’s because this group tends to provide a read on broader economic trends.

A quick look at regional banks in this chart should give pause…



4. Consumer sentiment
Twice a month, pollsters at the University of Michigan call 500 households to ask about their personal sense of well-being and their opinion on where the economy is headed. The latest reading, which will be released this Friday, April 13, could be a tough one because it comes on the heels of last Friday’s underwhelming monthly employment report.

The consumer sentiment reading stood at 77.1 at the end of March, which was among the highest readings in four years. (The index peaked at 77.5 in early 2011 and then slumped badly into the summer, dropping to a low of 55.7 last August.)

This time around, economists are all over the map, with some expecting a pretty sharp pullback to 74, which would be the lowest of 2012 so far, while the most bullish economists anticipate a move up to around 78.5.

Risks to Consider: It’s crucial that you not fixate on one data point to dictate your next move. Economic data are notoriously erratic, and the trend is more important than any single reading.

Action to Take –> Treat these data points as part of a mosaic. If all of them are pointing in the same direction, then you need to take heed. Friday’s employment report was surely sobering, as was the just-released NFIB Small Business Optimism Index. Even as you track earnings season, keep an eye on these indicators and plan accordingly.  

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