UPDATE 1-Wall St Week Ahead: Political wrangling to pinch market's nerves

NEW YORK, Nov 25 (Reuters) - Volatility is the name of this

game.

With the S&P 500 above 1,400 after five days of gains,

traders will be hard pressed not to cash in on the advance at

the first sign of trouble during negotiations over tax hikes and

spending cuts that resume next week in Washington.

President Barack Obama and U.S. congressional leaders are

expected to discuss ways to reduce the budget deficit and avoid

the "fiscal cliff" of automatic tax increases and spending cuts

in 2013 that could tip the economy into recession.

As politicians make their case, markets could react with

wild swings.

The CBOE Volatility Index, known as the VIX, Wall

Street's favorite barometer of market anxiety that usually moves

in an inverse relationship with the S&P 500, is in a long-term

decline with its 200-day moving average at its lowest in five

years. But the VIX could spike if dealings in Washington begin

to stall.

"If the fiscal cliff happens, a lot of major assets will be

down on a short-term basis because of the fear factor and the

chaos factor," said Yu-Dee Chang, chief trader and sole

principal of ACE Investments in Virginia.

"So whatever you are in, you're going to lose some money

unless you go long the VIX and short the market. The 'upside

risk' there is some kind of grand bargain, and then the market

goes crazy."

He set the chances of the economy going over the cliff at

only about 5 percent.

Many in the market agree there will be some sort of

agreement that will fuel a rally, but the road there will be

full of political landmines as Democrats and Republicans dig in

on positions defended during the recent election.

Liberals want tax increases on the wealthiest Americans

while protecting progressive advances in healthcare, while

conservatives make a case for deep cuts in programs for the poor

and a widening of the tax base to raise revenues without lifting

tax rates.

"Both parties will raise the stakes and the pressure on the

opposing side, so the market is going to feel much more

concerned," said Tim Leach, chief investment officer of U.S.

Bank Wealth Management in San Francisco.

"The administration feels really confident at this point, or

a little more than the Republican side of Congress may feel,"

he said. "But it's still a balanced-power Congress so neither

side can feel that they can act with impunity."

THE MIDDLE EAST AND EUROPE

Tension in the Middle East and unresolved talks in Europe

over aid for Greece could add to the uncertainty and volatility

on Wall Street could surge, analysts say.

An Egypt-brokered ceasefire between Israel and Hamas came

into force late on Wednesday after a week of conflict, but it

was broken with the shooting of a Palestinian man by Israeli

soldiers, according to Palestine's foreign minister.

Buoyed by accolades from around the world for mediating the

truce, Egyptian President Mohamed Mursi assumed sweeping powers,

angering his opponents and prompting violent clashes in central

Cairo and other cities on Friday.

"Those kinds of potential large-scale conflicts can

certainly overwhelm some of the fundamental data here at home,"

said U.S. Bank's Leach.

"We are trying to keep in mind the idea that there are a lot

of factors that are probably going to contribute to higher

volatility."

On a brighter note for markets, Greece's finance minister

said the International Monetary Fund has relaxed its

debt-cutting target for Greece and a gap of only $13 billion

remains to be filled for a vital aid installment to be paid.

Still, a deal has not been struck, and Greece is

increasingly frustrated at its lenders, still squabbling over a

deal to unlock fresh aid even though Athens has pushed through

unpopular austerity cuts.

HOUSING DATA COULD CONFIRM RECOVERY

This week is heavy on economic data, especially on the

housing front. Some of the numbers have been affected by

Superstorm Sandy, which hit the U.S. East Coast more than three

weeks ago, killing more than 100 people in the United States

alone and leaving billions of dollars in damages.

The housing data, though, could continue to confirm a

rebound in the sector that is seen as a necessary step to unlock

spending and lower the stubbornly high unemployment rate.

Tuesday's S&P/Case-Shiller home price index for September is

expected to show the eighth straight month of increases,

extending the longest continuous string of gains since prices

were boosted by a homebuyer tax credit in 2009 and 2010.

New home sales for October, due on Wednesday, and October

pending home sales data, due on Thursday, are also expected to

show a stronger housing market.

Other data highlights this week include durable goods orders

for October and consumer confidence for November on Tuesday and

the Chicago Purchasing Managers Index on Friday.

At Friday's close, the S&P 500 wrapped up its second-best

week of the year with a 3.6 percent gain. Encouraging economic

data this week could confirm that regardless of the ups and

downs that the fiscal cliff could bring, the market's

fundamentals are solid.

For the year, the benchmark Standard & Poor's 500 Index

is up 12.1 percent.

In Friday's post-Thanksgiving rally, the Dow Jones

industrial average jumped nearly 173 points to close back

above 13,000 - putting the Dow up 6.5 percent for the year. The

Nasdaq Composite Index is up 13.9 percent for 2012.

Jeff Morris, head of U.S. equities at Standard Life

Investments in Boston, said that "it's kind of noise here" in

terms of whether the market has spent "a few days up or down. It

has made some solid gains over the course of the year as the

housing recovery has come into view, and that's what's

underpinning the market at these levels.

"I would caution against reading too much into the next few

days."

(Wall St Week Ahead runs every Sunday. Questions or comments

on this column can be emailed to:

rodrigo.campos(at)thomsonreuters.com)

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