Market Insider

Published: Sunday, 1 Nov 2009 | 10:25 AM ET

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Brace for more volatility in the week ahead as investors wrestle with dual concerns that stocks have gotten too pricey and that the economic recovery is just too uncertain.

Stocks start November on wobbly footing, after the past week's selling helped erase October's gains and pushed the S&P 500 to its first monthly loss since March.

The Dow fell 2.6 percent for the week, finishing at 9712 but it was a half percent higher in October. The S&P 500, at 1036, was down nearly 2 percent for the week and 4 percent for the month, ending a run of 7 monthly gains.

Fresh manufacturing data Monday and the key October jobs report Friday are critical pieces of data for markets puzzling over the shape of the economic recovery. The dollar will continue to play a central role.

The Fed's meeting mid week has taken on even more importance because of speculation members may want to signal they are looking ahead to higher interest rates. Many Fed watchers, however, do not believe the Fed will take any action or change language in its statement about interest rates until early next year.

"I think the first hurdle is the Fed. Once we get through the Fed, that will be the catalyst that probably calms markets down," said Adam Boyton, currency strategist at Deutsche Bank.

Boyton said he does not believe market speculation that the Fed will drop the language in its statement that says it will keep rates low for an "extended period." That should put pressure back on the dollar.

A weaker dollar has meant rising risk assets, such as stocks and commodities. In the past week, the dollar gained against the euro and other currencies. At the same time, stocks struggled and most commodities fell. The stock market, however, had one very good day Thursday, with the Dow adding nearly 200 points on a slightly better than expected third quarter GDP reading of 3.5 percent.

"What's not really healthy is the big blow up Thursday and then this negative day back to back. That's not healthy for the market," said one trader as the Dow plunged nearly 250 points Friday. As stocks moved lower, the Chicago Board of Options Exchange's VIX, or volatility index, shot higher, signaling increased fear in the market Friday.

"The reason the VIX popped so much is because of the out of the money put buying in the S and P 500," said Patrick Kernan of Cardinal Capital. "A level over 30 means people are panicked about this market being choppy over the next couple of weeks." The VIX rose 24 percent Friday to 30.69.

"The price to cover downside risk, meaning a break in the market, has gone up incredibly," he said. Kernan said the VIX is now implying a daily move of as much as 19 points in either direction.

Technical strategist Scott Redler, of T3Live.com, said he thinks the S&P 500 could test the 1020 level next week, and that trading will be choppy. "If things start to intensify, there's very good support at 980," he said.

Whither Stocks

Citigroup's chief U.S. equities strategist Tobias Levkovich said he thinks the market may have seen its highs for the year. "We were telling investors that we thought the market would end at around 1000 for the year, and we could see an overshoot to 1100, which we have seen," he said.

Levkovich said if the market moves higher into year end, as some others believe, then the beginning of 2010 will be more challenged. "I'm not convinced we're going to have a great run at year end. Investors are really struggling with where we go from here," he said.

He now expects to see the stock market move higher in the beginning of 2010, possibly to 1200 on the S&P, before backtracking in the second half of the year.

"As you get to mid year, you're going to start to think about the Fed's exit strategy. You're going to worry about the stimulus not providing expansionary money into the economy and you're going to worry about the Bush tax cuts expiring," he said.

Levkovich said some of the things he saw as positives for stocks are fading. He said investor sentiment has improved and that is a contrarian signal. "I spoke to investors in the last couple of weeks and there is really noticeable anecdotal bullishness," said Levkovich. He also said stocks are now at fair value and there is less chance of momentum from earnings revisions going forward.

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