By Caroline Valetkevitch
NEW YORK (Reuters) - Shell-shocked stock investors will search this week for calm to return to markets after the worst three weeks for stocks in 2-1/2 years.
With the blow from the August 5 U.S. credit rating downgrade behind them, investors will focus on the outlook for the U.S. economy as well as signs that European policymakers may be able to contain the euro zone debt crisis.
Widespread investor panic put the market on a roller-coaster ride last week, with steep losses followed by nearly-as-steep gains in high-volume trading. It was the busiest week for volume since October 2008.
Though investors are still searching for a bottom in the selloff that has taken the benchmark Standard & Poor's index <.SPX> down 12.4 percent since July 22, indexes rose both Thursday and Friday -- the S&P index's first two-day rally since mid-July -- and volatility eased.
The move could set stocks up for a calmer week, especially if economic data shows the United States is not headed for another recession, strategists said.
"Every bit of data that shows the economy not slipping into recession is going to be the basis for the market to begin to calm down in the weeks ahead," said Peter Cardillo, chief market economist at Rockwell Global Capital in New York.
While Wall Street stocks ended higher on Friday, the market fell for the week. The Dow fell 1.5 percent and the Nasdaq lost 1 percent. The S&P 500 fell on 11 of the past 15 days, dropping 12.4 percent in three weeks.
Housing and manufacturing reports are among indicators on tap, including the New York and Philadelphia Federal Reserve regional manufacturing surveys and existing home sales.
Manufacturing has been among the strongest sectors of the economy, but a report earlier this month dented that picture.
The Institute for Supply Management manufacturing report, a gauge of factory activity, fell to in July to its lowest in two years and was barely above the mark dividing growth and contraction.
It was quickly followed by an ISM report showing the pace of growth in the U.S. services sector ticked down unexpectedly.
More recent data has suggested the economic recovery will stay on course.
U.S. Commerce Department data on Friday showed retail sales posted the biggest gains in four months in July, which was a catalyst for stocks to rise.
"We think the deterioration in the U.S. macro outlook got us into this mess and will likely get us back out," said Barry Knapp, head of US equity portfolio strategy at Barclays Capital in New York.
"If we're right ... we will get the stock market to trade at least back into its old 1,250 to 1,350 range that prevailed from March through the recent downturn."
Retail earnings were among the few bright spots in the market last week. Kohl's Corp
Results from more top retailers are expected this week, including Wal-Mart Stores
"I will be looking for any data that show what back-to-school (sales) might look like, and later, into the fall, we'll be looking for what the holiday season might look like," said Natalie Trunow, chief investment officer of equities at Calvert Investment Management in Bethesda, Maryland, which manages about $14.8 billion.
Earnings growth for the second quarter is expected to have risen 11.8 percent, according to Thomson Reuters data, and many analysts consider the solid growth to remain a cushion for stocks going forward.
The S&P 500's price-to-earnings ratio is at 10.46, according to Thomson Reuters data, considered cheap by historical standards.
That valuations are cheap suggests to some strategists that stocks remain attractive, especially when compared with U.S. Treasuries, but others say earnings expectations are likely to deteriorate going forward.
Besides concerns about the U.S. economic outlook, worries about the European debt crisis persist.
Investors look forward to a meeting this week between French President Nicolas Sarkozy and German Chancellor Angela Merkel, who are expected to discuss how to make the euro zone work more effectively in dealing with the crisis.
Technically, the market remains weak.
"Most technicians would agree that the long-term market cycle has been damaged, given two-year uptrends have been broken, monthly momentum indicators have turned down, and a lengthy list of stocks have collapsed through important long-term support levels on expanding volume," analysts at RBC Capital Markets said in a research note Friday.
Bruce Zaro, chief technical strategist at Delta Global Asset Management in Boston, said one sign the market's downturn may not be over is a measure of stocks with 52-week highs versus 52-week lows, which is low.
(Reporting by Caroline Valetkevitch; editing by Kenneth Barry)