Market May Find a New Source of Anxiety—Washington

As investors watch Europe in the week ahead, the news from Washington may start to become an increasing source of market anxiety.

European officials in the past week wrestled with Greece on its bailout, which helped drive stocks to their first weekly loss in six weeks. Europe, particularly the creeping worries about Italy, will stay at the top of the list for investors.

But as Washington edges towards a Nov. 23 deadline, traders are likely to start handicapping the work of the bipartisan Congressional Super Committee, tasked with reducing the deficit by $1.5 trillion.

"I think we might get a little more focused on the headlines out of D.C.," said Barry Knapp, head of equity portfolio strategy at Barclays Capital.

European finance ministers meet Monday and Tuesday, after G20's leaders meeting fell short of expectations. The summit failed to generate support from countries outside Europe to participate in the bailout, and a role for the IMF was left unclear.

Leading up to the summit, European leaders were dealing with a threat from Greek Minister George Papandreou to hold a public referendum on the bailout, an idea later dropped. As Papandreou's government teetered on collapse, he survived a confidence voteby the Greek parliament Friday evening.

Italy also become an important concern for markets this past week, as it agreed to accept IMF scrutiny of its fiscal reforms. Yields on 10-year Italian bonds topped 6.4 percent. Italy holds a bill auction on Thursday.

"Next week is going to be all about Europe. You don't have earnings. You don't have central banks. You don't have the jobs report. You have a bunch of 'B' level economic indicators. Next week is likely to be a cooling off period," said Dan Greenhaus, global market strategist with BTIG.

"...We can now turn our attention to yet another humungous land mine in the investment environment — the Super Committee," he said. "...You have to imagine test balloons will come out."

Analysts have been concerned that as the Super Committee comes down to the wire on its plan, tensions will run high and the acrimonious tone surrounding the debt ceiling debate last summer could again dominate headlines. They blame that public wrangling, which led to the downgrade of U.S. debt, for a clear falloff in business and consumer confidence.

There were reports this week that a six-member subset of the 12-member Super Committee is working to find a solution, since the two parties are so far apart on taxes and spending. If the committee does not reach a deal by the deadline, there are $1.2 trillion in spending cuts that will automatically be triggered across government agencies, starting in 2013.

"They're not going to get any grand bargain. They'll probably meet the minimum standard," Knapp said.

Knapp said the timing of the committee's deadline for late November may be a factor that could help derail a Santa rally this year.

"We have five non-holiday weeks left in the year," he said. "The window is closing. I'm not as bullish as I was either a month ago, because of prices and because of time. You're running out of time for a year end rally and the outlook for the beginning of the year is not that great." Before this past week, stocks had recovered about 17 percent of their summer and early fall losses.

The Dow in the past week lost about 2 percent to 11,983, and the S&P 500 was down 2.5 percent to 1253.

Knapp said the past week was a turning point for markets, as it held so many major events, including a Fed meeting and the October employment report. The jobs reportshowed a net increase of 80,000 nonfarm payrolls, but upward revisions for the past two months encouraged economists that the trend is improving.

"To me this week was crucial in our thinking for the potential upside for the balance of the year. If we had gone through this week and it had been all about the U.S. data, we'd probably be above 1300 (on the S&P 500) right now," he said. Knapp said the markets also learned from the data in the past week that the economy in Europe is deteriorating, and even new European Central Bank President Mario Draghi warned a recession was possible.

As for the coming week in the U.S., there are some major earnings, with retailers and media companies the highlights. Disney, Viacom, Macy's and Nordstrom are all reporting. The economic data highlights are the usual weekly claims, but also trade data and consumer sentiment. The government auctions $72 billion in Treasury notes and bonds Tuesday through Thursday.