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Week Ahead: Big Stock Rally May See Big Pullback

Wall Street's bull could take a breather in the week ahead, but the trend for stocks remains higher, for now.

Stocks in the past week gained another 2 percent as improved reports on employment and manufacturing activity confirmed expectations the economy is showing signs of recovery.

Wall Street Trader
AP
Wall Street Trader

Treasurys came under selling pressure, driving yields higher, and the dollar finished the week firmer.

In the week ahead, investor focus will be on the Treasury market and dollar as much as the Fed's two-day meeting midweek and a heavy calendar of economic reports.

Retail sales are released Thursday, and there are just a few major earnings reports, including Wal-Mart and several other chain stores.

"I suspect the market is going to retrace a little bit next week. I would be surprised if it didn't," said Tim Smalls of Execution LLC. "People keep saying there's a lot of money on the sidelines, waiting to come into the stock market. I'm not so sure. I think you need to have some kind of pull back, and then more people come into the market."

Another record round of Treasury auctions is scheduled for the coming week and could prove a disadvantage for stocks if rates continue to rise.

The yield on the 10-year reached 3.852 percent Friday on better economic news and concerns about the looming Treasury issuance, which includes $75 billion in notes and bonds and billions more in short-term bills.

Rising Rates

John Spinello, Treasury strategist at Jefferies, said the supply will likely pressure the bond market enough to push rates on the 10-year to 4 percent, a widely watched level it last touched in June.

The Treasury plans to auction $37 billion three-years Tuesday; $23 billion in 10-years Wednesday, and $15 billion in 30-years Thursday.

"It's the supply pressure, the sentiment change about the economy, and the concern about foreigners not participating in the auctions," said Spinello.

Spinello, however, doesn't think the rise in rates will necessarily stall the equities markets as it did in June.

"Rates can go up and stocks can go up at the same time," he said.

Pimco senior strategist Tony Crescenzi said it's likely the economic news will continue to improve, a bearish trend for the Treasury market.

Friday's July employment report, which showed a smaller-than-expected decline in non-farm payrolls, reinforces the trend.

"There has been no interruption in the improving tone of the data and so long as that is the case, trends in markets will be held in tact.

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The more the economic and financial conditions improve and yields rise, the more the risk asset classes, stocks and corporate bonds, will pay attention to the rise in interest rates," he said.

Even so, rising rates could be their own undoing.

"When you think of how the other asset classes might behave, that could truncate any rise in interest rates," he said.

The stock market will certainly be sensitive to any rise in interest rates, said James Paulsen, chief investment strategist with Wells Capital Management.

"These are exactly the things that cause the market to consolidate. I would also say 4 percent this time is not as damaging as 4 percent was last time because we're no longer losing 500,000 jobs a month," he said.

Paulsen said he is watching weekly jobless claims data Thursday to see if it reinforces the trend of slowing job losses seen in July's employment report.

"Could the market pull back some? Could it consolidate some? Sure. It surely will at some point here. But I'll be darned if it's now or if does it at 1100," said Paulsen.

PNC's Stone: Less Friendly Market Ahead

PNC's Bill Stone also sees the potential for a pullback and said the market sentiment is likely to get a little less friendly as the rally runs on. The S&P 500 has now gained 50 percent since its March low.

"When I look at the valuations versus the normalized earnings number we use, stocks still aren't expensive.

They aren't as cheap as they were, but it argues for me to stay in there," said Stone, chief investment strategist with PNC Wealth Management.

Stone said he expects the market to stay in an uptrend through the summer.

"We do have an improving economy that we didn't have before," he said. "It's better to have a tail wind than wind in your face."

Among the sectors he likes best are consumer discretionary and technology.

Markets Mayhem

The dollar was higher on the week, but it made most of its move up Friday after the jobs data, reversing an earlier move lower.

Traders watched this reversal with interest because it is counter to the typical moves the dollar has made lately.

The dollar, in a "risk" or "reflation" trade, usually moves lower as stocks and commodities rise.

The idea that rates will rise because of good economic news was a factor.

"The market is pricing in Fed tightening very early next year. But that seems very unlikely," said Marc Chandler, chief currency strategist at Brown Brothers Harriman.

Traders debated Friday whether the dollar's behavior means a new bottom has been carved out for the green back and also whether it indicates the U.S. will now recover faster than the rest of the world.

The dollar gained 0.6 percent against the euro for the week, but jumped 1.3 percent Friday alone.

To Chandler, the dollar's move higher is likely temporary. For instance, the Fed will not be tightening in the near future, and there is also no wider interest rate differential to justify it.

"It's hard to get a lot of conviction on just one day's move....I think what it means for next week is the Fed is going to have something in its statement to remind people that rates will be low for some time," he said.

As for commodities, oil gained 2.1 percent to $70.93 per barrel in the past week, while gold rose 0.4 percent to $957.30. Silver was 5.2 percent higher, and copper was up 6.3 percent.

Econorama

Crescenzi said the Fed, in its statement Wednesday, will most certainly acknowledge improvements in the economy and in financial conditions.

"Secondly, it will indicate that it will reign in and stamp out inflation pressures as they arise. That's something they need to say because there is a camp out there that recognizes the data is getting better and that could pose inflation problems. But at the same time, they need to say that's way off," he said.

The Fed's two day meeting ends Wednesday at 2:15 p.m. with a statement.

Economic reports in the coming week include the NFIB small business survey which is released Tuesday, as are productivity and costs and wholesale trade.

Wednesday's data includes international trade and the federal budget.

On Thursday, weekly jobless claims, import prices and business inventories will be reported in addition to retail sales.

Consumer prices for July, industrial production and consumer sentiment are released Friday.

Whither Stocks

The Dow in the past week gained 2.2 percent to 9370, while the S&P 500 was up 2.3 percent to 1010.

Paulsen also said the "fear" factor that sent markets spinning lower last year is now turning out to be an advantage.

"Fear last year was one of our biggest problems. It's now become one of our biggest assets. Because our policy officials were so fearful last year, they shut us down with their policy and their words. They also did one other thing that's now a huge benefit - they over eased," he said.

"We would have gotten nowhere near the juice if they weren't so scared." "Secondly the fear in the business community caused companies to purge inventories and people," Paulsen said.

Companies now have operating leverage that should boost growth.

"They overdid it." Paulsen said in a climate like this, an important thing to watch is the market's technicals.

Scott Redler, of T3Live.com, is a technical strategist who watches the market's short term moves. He said the S&P 500 hit an important level Friday, 1015.

"The 1015 was the 38.2 percent retracement that a lot of technicians have been watching. That's an area that institutions sell," he said.

Redler said he believes the stock market's gains are now limited before it has a 10 to 15 percent retracement, and that it may have reached its highs for the summer.

"It could be that we've built ins a short term summer top, as we approach a seasonally soft time for stocks," he said.

The next area of resistance would be 1015, and that level could take the S&Ps to 1040, he said. If stocks decline, the support level for the S&P is 1000, a key psychological level.

Earnings Central

Wal-Mart reports Thursday, as does Nordstrom and Kohl's . Macy's is Wednesday and J.C. Penney reports Friday.

Other companies report in the week ahead include Dish Network , Dynegy , Priceline.com , Sysco , Fluor , and McDermott Monday.

On Tuesday, Applied Materials reports after the bell. Sara Lee and Harris report Wednesday, and Dr Pepper Snapple , Estee Lauder and Autodesk report Thursday.

Questions? Comments? marketinsider@cnbc.com

  • Patti Domm

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

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