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Week Ahead: Market Still Feels Sting of the Credit Crisis

Wall Street will keep a cautious eye on Europe in the week ahead, as the global credit crisis proved it still carries a potent sting for markets.

Concerns about European sovereign debt started with Greece early in the past week and moved onto Portugal, Spain and other countries. By Thursday, a global sell off intensified, taking stocks and commodities lower. The dollar firmed, the euro fell, and investors fled to the relative safety of U.S. Treasurys.

"I don't think this correction is necessarily over, and we'll get some rallies, but we've got to repair some damage technically. I don't think we're in for some big bear market, if the global recovery continues," said BlackRock Vice Chairman Robert Doll.

"We had a credit bust and too many people thought, 'well, it looks like we solved our credit problems,' he said. "There are credit problems all over the place, and they are showing up in Greece now. There will be a consortium of European governments that come together and they'll come up with a band aid. This is not the last credit problem that we're going to hear about."

There is little U.S. economic data in the week ahead. The most important item on the calendar is retail sales for January. The Euro zone, however, will release fourth quarter GDP data Friday. There is also inflation and trade data from China.

Fed Chairman Ben Bernanke testifies before Congress Wednesday on the Fed's plans to unwind stimulus, and the G-7 finance ministers meet in a remote part of Canada this weekend. The U.S. Treasury is holding auctions for more than $80 billion in notes and bonds. On the earnings front, Coke, Disney, UBS and Pepsi are among the companies reporting.

Doll said markets continue to fret about whether China will harm the global recovery with its efforts to cool its own economy by tightening lending. There is also concern about what actions the Obama Administration might take,following a Democratic loss in the Massachusetts Senate race, which took away the party's 60-seat majority.

Traders are sharply focused on news from Washington. Markets were unsettled by the Administration's plans to limit risk-taking by banks, the subject of Congressional testimony this past week. Also, the Obama Administration unveiled its $3.8 trillion budget, signaling a sure hike in taxes.

Markets Mayhem

Stocks are down about 7 percent from their January highs. Doll says the market could correct 10 percent or more. "Could we probe lower? Of course we could, but I think it's in the 10ish level," he said. "I don't think this is going to be 20 percent."

"I don't get too hung up on these sort of things and get worried. I think this is just a pause to refresh," said Doll. He said this type of trading event is more "normal" than what the market saw last year, when it kept rising straight up with only very shallow pull backs.

Doll said sovereign debt issues will be a big focus in the coming week. "That'll be the main story of the week.. but earnings have been pretty good, and hopefully that will make some people feel better," he said.

The dollar gained 1.5 percent in the past week against the euro, finishing at $1.3665 per euro. The dollar fell nearly 1 percent against the yen but rose 2.25 percent against British sterling.

Oil lost 2.3 percent to $71.19 per barrel, and gold tumbled 2.8 percent to $1,052.20. Treasurys gained, sending yields on the 10-year lower to 3.546 and the 2-year to 0.764

Friday's Roller Coaster

Friday's stock market action gave traders encouragement, at least in the short run. Stocks finished marginally higher Friday, but not before taking a deep swoon in mid afternoon. The market then staged a rapid turnaround as massive short covering helped push it into positive territory in the final hour. The Dow ended at 10,012, up 10, and the S&P was up 3 points at 1066. The Dow finished the volatile week just half a percent lower, and the S&P was off 0.7 percent.

"It was a very shocking day. When we were nearing the bottom and went below 1050, there was certainly panic in the air. Volatility got pretty cranked up there for awhile," said Patrick Kernan, who trades S&P 500 options at the Chicago Board Options Exchange

"We were a little long at the close. We decided to go out a little bit bullish. It was much more for a shorter term play than long, and it was because we saw it come back so much," he said. The VIX, the CBOE's volatility index, also moved sharply, edging close to 30 at one point in the day Friday before finishing the week at 26.11.

Kernan said there was a lot more complacency at the end of the trading day Friday. "...It definitely feels like there was a lot of second guessing, just by the nature of the trades..like people would do a trade and say 'whoops!, maybe they didn't want to do that. You saw a lot of stuff unwinding pretty fast."

Euro Trashed

Euro Trashed

The popular "risk trade," where the dollar weakened and stocks and commodities rose, dominated markets in the past year. Traders say some of the momentum behind last week's selling of stocks and commodities was a big unwind of that trade by some investors. The question now is whether it represents a more permanent change as the euro continues to weaken under concerns about European debt.

"The real story started three to four weeks ago when China said it was restricting bank lending, so ultimately whatever rebound we get in risk assets we'll look at as a selling opportunity," said Brian Dolan of Forex.com. He said it appears stocks have made a short term bottom and he expects to see some consolidation in the next week.

Jordan Kotick, global head of technical strategy at Barclays Capital, said many markets showed signs of technical wear. He said instead of looking at levels on stock indices, he thinks investors should watch the level of the German 10-year Bund, the beneficiary of a flight to quality.

He said late Friday that the German Bund was at a key level of 3.11 percent. "When that breaks, and I think it will, it will take the markets below any magic pivot level on European markets. The sentiment is from Europe so watch the European bond market," he said.

"Portuguese 10s are currently at 4.70 and Greece is at 6.60. The key is the spread is widening. For the year, the German 10-year Bunds are 22 bps bullish. Greece is 92 bps bearish," he said.

"I think it's ugly and I don't think it's done," he said Friday, before the U.S. market closed.

Kevin Ferry of Cronus Futures Management said he thinks the issues in Europe appear to be contained, for now, and that the European Central Bank has a lot of fire power left. "If we were experiencing real problems, and things were breaking down then Libor would be rising. It's not. The term structures are making new all time lows," Ferry said.

RBS chief economist Stephen Stanley said the situation with European sovereign debt is reminiscent of the Thanksgiving weekend scare over whether Dubai would be able to cover its debt payments. "This seems a little more severe for the moment but I don't know if (Thursday's market) reaction was all that much different," he said.

"The Eurozone is going to come in and bail out Greece. The question everyone is going to ask right now, and everybody has their head on a swivel, is what's going to be the next thing," he said.

He said so far there does not seem to be an indication of economic impact for the U.S. "Our economy is not going to tank because Greek consumption goes down. If things are less orderly and you have a big effect on the financial markets. than it does," he said.

Even if there is a continued decline in the euro currency, he still does not expect an immediate impact on the economy. "Typically these effects from currency swings on trade flows come with a pretty significant lag so it's not something that's going to affect these shores this week, next week or next month," he said.

"To me it's only concerning in that the reaction seems to have been outsized. Is that telling us something? Is that telling us something just about psychology, where things would flip around quickly, or is it telling us something sinister is lurking under the surface," he said.

Econorama

Thursday's January retail sales is the number to watch in the week ahead. "We're looking at a headline of 0.3 but broad based strength outside of the auto sector," said Stanley.

There is no data of note Monday. On Tuesday, the Treasury releases international capital flow data. The NAHB home builders survey and the NFIB small business survey are also released that day. International trade data is reported Wednesday, while Thursday's data includes weekly jobless claims and business inventories, in addition to retail sales. Consumer sentiment is released Friday.

Oil and the Week's Earnings

Oil Drill

In the oil markets, crude broke through its 200-day moving average and fell below $70 per barrel before closing higher. John Kilduff of Roundearth Capital said he thinks the selling is coming to an end. "I think it should stabilize," he said. Energy markets "give the economic recovery story every benefit of the doubt. Obviously, there's a reality check that's under way here. It's kind of post traumatic stress syndrome. It does feel like Lehman and Bear Stearns days again with these sovereign debt issues," he said.

The energy markets are watching Iran in the coming week as the 10-day commemoration of the 31st anniversary of the Islamic revolution comes to an end. Both defeated presidential candidates in last June's election have called for massive protests on Thursday. In addition, Iranian President Mahmud Ahmadinejad has previously used the anniversary to make announcements regarding the country's nuclear program.

Earnings Central

Monday's reports include CNA, CVS Caremark, Hasbro, Nasdaq OMX, Electronic Arts and Hartford Financial. Coca-Cola , UBS , Biogen Idec, Molson, Pulte Homes, Celanese, and NYSE Euronext report before the bell Tuesday. Disney and Baidu report after the bell that day.

On Wednesday, Sanofi-Avantis reports, as does New York Times, Marsh and McLennan, Arcelor Mittal, Companhia Vale do Rio Doce, Prudential Financial and Allstate. PepsiCo and Philip Morris, as well as Marriott, Alcatel-Lucent, AutoNation and Expedia report before Thursday's bell. McAfee, Beckman Coulter and Cephalon report Friday.

Questions? Comments? Email us at marketinsider@cnbc.com

  • Patti Domm

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

  • A CNBC reporter since 1990, Bob Pisani covers Wall Street from the floor of the New York Stock Exchange.

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  • JeeYeon Park is a writer for CNBC.com. Follow her on Twitter: @JeeYeonParkCNBC

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