Market Snapshot May 23, 2009, 12:01 a.m. EST Wavering rally faces GM failure, slew of housing data By Laura Mandaro , MarketWatch

SAN FRANCISCO (MarketWatch) — A nearly three-month rally in stocks will square off against a possible General Motors Corp. bankruptcy and a round of new housing data during the holiday-shortened trading week.

How this tussle turns out will help shape the ongoing debate about whether the stock market’s 33% gains since its March low represent a sustainable rally or just a bounce in a bear market.

Though they ended last week higher, the benchmark indexes fell back for four of the five sessions, weighed down by a growing sense that investors had overbid for shares given what’s likely to be a slow, jagged economic recovery.

“The market’s had a big run-up, now it’s running out of steam,” said William Rutherford, president of Rutherford Investment Management in Portland, Ore., and the state’s former treasurer.

He noted that even though the stock market has continued to rise, it’s done so on lighter volume. “That shows it’s getting a bit tired.”

U.S. markets are closed Monday for Memorial Day.

Investors may return from the beach to witness the bankruptcy of General Motors (GM 1.43, -0.47, -24.74%) , the nation’s largest auto company.

Such a failure is largely baked into the broader market, say analysts. “It won’t be a surprise, it may even big a relief once it actually happens,” said Robert MacIntosh, chief economist and a portfolio manager at Eaton Vance.

But such a large collapse — involving tens of thousands of workers, closed dealerships and a hit to U.S. manufacturing output — has the power to shock even expectant markets.

On Friday, benchmark indexes skidded to a slightly lower close, dragged down by a 26% drop in GM shares. The company, running on billions of dollars in U.S. government aid, has until June 1 convince the Obama administration it can raise cash by converting some of its debt to an equity stake in the company, in addition to cutting labor costs, folding dealerships and selling brands. See full story.

But the company’s hand could get forced earlier. Its offer for bondholders to exchange their debt for equity, which many bondholders have condemned as inadequate, expires Tuesday night. If GM can’t extend the offer and doesn’t get the votes it needs, bankruptcy is probably a done deal.

A bankruptcy will add to the nation’s unemployment lines, which have shown early signs of recovery as first-time jobless claims dip from highs this year. Barclays estimates a GM bankruptcy would cause unemployment claims to spike higher in June as roughly 35,000 to 40,000 hourly GM workers file for government help.

“The disruptions in the auto sector will create volatility in the weekly and monthly economic data,” economists Ethan Harris and Dean Maki of Barclays Capital, in a report. That choppiness will make it difficult to call turning point, they noted.

A GM failure will also trigger a change to the main stocks benchmarks. A filing would prompt the publisher of the Dow Jones Industrial Average (INDU 8,277, -14.81, -0.18%) to remove it from the blue-chip average and could cause a revamp of other components. See related story.

Whither housing? Housing data on Tuesday, Wednesday and Thursday will give investors more information on how long it will take for housing to recover. That’s a key step in getting the U.S. out of recession and supporting a lengthier stocks rally. Last week, disappointing data on new home construction added to the sour mood on Wall Street.

Investors are “questioning some of the green shoot activity that we’ve been seeing over the last three or four weeks or so,” said Paul Nolte, director of investments at Hinsdale Associates. Next week, economists are expecting reports that show existing home sales likely dropped in April, economists say, while new home sales came in flat.

Investors will also get a dash of corporate news, with Costco Wholesale Corp. (COST 48.30, -0.01, -0.02%) , Staples (SPLS 19.37, +0.28, +1.47%) , Take-Two Interactive Software (TTWO 9.00, -0.23, -2.49%) and J.Crew (JCG 19.72, -0.30, -1.50%) reporting earnings results.

Washington will likely be quiet as Congress takes a recess. President Barack Obama will head to Las Vegas Wednesday for an event about the economy.

Oil markets, which have driven up oil futures to around $60 a barrel, will get fresh round of supply data. Members of the Organization of Petroleum Exporting Countries meet Thursday. They’re not expected to announce any further production cuts. Some members have even been ramping up output to take advantage of higher prices. See full story.

On Wednesday, the Energy Information Administration will give its long-run projections for international supply and demand.