By Jeremy Gaunt, European Investment Correspondent
LONDON, July 10 (Reuters) - There is a huge test ahead for investors next week as one of the two big questions facing them is answered -- how companies are faring in the global recession.
They will also be newly cognisant after this week's Bank of England meeting of the idea that central banks will eventually exit from their economic reflation strategies, a concept that has already set off some jitters.
Concerns that the global economy may not be heading for as quick a recovery as some had hoped have combined recently with angst about corporate earnings to bring the red-hot March-June equity rally to a screeching halt.
World stocks as measured by MSCI, for example, are down around 4 percent so far in the third quarter after soaring a record 21.2 percent in the second.
Next week, though, the U.S. earnings season gets underway big time and the results are likely to set the tone for markets for much of the rest of the year. "We'll need to see substantial improvements in economic and company fundamentals in order to sustain recent gains and expand the breadth of the rally," Enrique Chang, chief investment officer at American Century Investments said in a note.
As of Friday, two major U.S. companies had reported -- and given investors the same kind of mixed signals they are getting from economic data.
First, industrial bellwether Alcoa reported a third consecutive quarterly loss, but beat estimates by a large margin due to cost cuts. Them oil major Chevron warned that second-quarter earnings would be hit by a sharp decline in U.S. refining margins.
So it will be on to next week to get a clearer idea.
DELUGE
It offers a veritable who's who of American corporate aristocracy.
Among those reporting are big financials Goldman Sachs, JP Morgan, Bank of America and Citi (C.N, technology bellwethers IBM, Google and Intel, as well as big names such as GE, and Johnson and Johnson. Europe will also see the start of its season, with the likes of Nokia, Alstom, Novartis and Pernod Ricard reporting.
Thomson Reuters Proprietary Research says that analysts are now expecting a huge year-over-year decline in earnings from S&P 500 companies, something in the region of 35 percent.
But the research also notes that analysts have not been slashing their second-quarter earnings expectations with the same rapidity they did before the previous two quarters.
This could mean that they have now factored in the likely impact of the global recession on earnings. Alternatively, it could mean that analysts are far too optimistic about what is happening on a company level.
A study by consultants Absolute Strategy Research found a large and unusual variance between analysts' earnings revisions and corporate newsflows, with the latter now far more pessimistic than the former.
"Analysts are looking towards an upturn in global earnings that, as yet, our newsflow indicators are not detecting," the firm warned.
RUSH FOR THE EXIT
On the economic data front -- where investors are seeking hard confirmation that recovery is in the works -- the focus will be on U.S. inflation, retail sales and industrial production.
But investors are also having to deal with a new wrinkle, the idea that central banks are becoming reluctant to extend the kind of help to economies that they have been and will eventually have to roll some of them back.
This stems from the unexpected decision by the Bank of England this week not to extend its quantitative easing, essentially the non-interest rate way it pumps money into the economy.
There was a sharp jump in Treasury, euro zone debt and gilt yields on the news, showing what bond markets are likely to have to deal with when the event comes.
It is some way off, but a warning shot has been heard. (Editing by Toby Chopra)