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Europe Gives Market Heartburn, Sell-Off Could Continue

Ian Sanderson | Getty Images

Worries about Europe gave stocks agita Monday for the first time in months, and it may be the excuse to take profits from the new year rally.

The Dow Jones Industrial Average saw its worst decline since late December, falling 129 points, or 0.9 percent to 13,880, while the S&P 500 slipped more than 1 percent to 1495. The Dow is up nearly 6 percent year-to-date, and the S&P is up about 5 percent. The Nasdaq, dragged down by tech, lost 1.5 percent Monday to 3131, and is now up 4 percent for the year.

(Read More: Investors Getting Cold Feet Around Dow 14,000)

"I think we're due for a modest say, five percent pullback in the market," said Jeff Kleintop, chief investment strategist with LPL Financial. "Whether we've seen the start of that today ,with a one percent move, or whether we bounce back and it is yet to come. … February is a good month for it to happen."

Spain and Italy were the culprits, and their stock markets saw sharp losses as investors focused on reports of a corruption scandal involving Spanish Prime Minister Mariano Rajoy and on uncertainty over the outcome of the Italian election this month. The focus will remain on Europe later in the week as well, when the European Central Bank meets Thursday. The euro was slightly lower but held above 1.35, after last week's big move higher.

"It's been the tone for the last two or three years. Europe hits us somewhere in the spring," said Kleintop. "We kind of pull higher later in the year ... it's a different type of risk in Europe. It's not so much a financial crisis, it's economic. But it still echoes the same thing. It's still ground hog day."

(Read More: Why the Euro Seems Headed for a Fall)

Barry Knapp, head of equity portfolio strategy at Barclays, said the market is ripe for a pullback, but it may not be just yet. Working against it are earnings revisions. "Earnings are beating in the current quarter but expectations are coming down," he said. Knapp said the market may make another run at the highs before pulling back.

Both the S&P and Dow crossed important psychological hurdles recently, and analysts have said that 1500 on the S&P and 14,000 on the Dow may be reason enough for the market to pause. All-time highs are close at hand — 14,164 for the Dow, for one. "I think there's a pretty good case for things being better in the second half," said Knapp. "I wouldn't be surprised if we've seen the highs for the first half. Maybe we have another new high in here, but I do think the market has overshot the fundamentals."

Tech stocks were the laggard, down 1.6 percent Monday, and telecom was the best performer, down 0.5 percent. Year-to-date, energy is leading with a 7.5 percent gain, followed by financials and health care, both with a more than 5 percent gain. The S&P tech sector is up just 0.9 percent for the year.

"I think what people have overlooked to some extent is that the best performing sector year-to-date is energy," he said. "Typically when energy has been a lead, that's not really been good news for the market. The health care sector is second. That's not really about growth. Last week, when we hit the high, the best sectors were defensive."

(Read More: How S&P Gets to 1,600: Barry Bannister)

Knapp said he doesn't expect the market to make it through the second quarter without a correction. "I view the points of strength to be transitory and the points of weakness not being so transitory," he said. "To me, it's plausible (the pullback) has begun."

While Kleintop also says it may be time for the pullback, he remains positive on the year. "I am encouraged that there is a great rotation over the course of the year, and I don't think the bull market is over yet," he said, referring to the view that investors will sell bond holdings this year and move to stocks after years of bond market gains.

Scott Redler of T3Live.com said he is cautious on the stock market short-term but more bullish intermediate and longer term. Redler watches the short-term technicals.

"It was kind of surprising," he said of the selloff. "We closed at the highs last week. Everybody was looking for an excuse to take some profits. I think this will help take away the performance anxiety." Redler said there a lot of investors that missed the January move and are looking for an entry point.

(Read More: Why Companies Have Gone Sour on Stock Market)

"Everyone's been asking for one. Here we potentially are starting one. The points of interest are the 21-day moving average at (S&P) 1483 and right under that is the prior September pivot high of 1474," he said. "A pullback to that area I would be excited to see. That's a good spot." He said if that level would hold and encourage dip buying, it would be a refresh point for the rally.

What to Watch:

Non-manufacturing ISM is released at 10 a.m. The JOLTS data is released next week, not today as I earlier reported.

There are some key earnings before the bell, including BP, Archer Daniels, Toyota, UBS, Automatic Data, Kellogg, NYSE Euronext, Sirius XM, Eaton, Becton Dickinson, Arch Coal, Cardinal Health and Diamond Offshore. Companies reporting after the bell include Disney, Chipotle, Panera Bread, Shutterfly, Zynga, Hain Celestial, Genworth Financial, Aflac, CME Group and Suncor.

President Obama meets with a group of business leaders, including Goldman Sachs CEO Lloyd Blankfein.

  • Patti Domm

    Patti Domm is CNBC Executive Editor, News, responsible for news coverage of the markets and economy.

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