Stocks are likely to stay on edge in the coming week, with investors focused on Europe's sovereign credit woes in the short term, and a world with less government-induced stimulus in the long term.
U.S. markets reopen Tuesday, after Monday's President's Day holiday. That is also the second day of meetings of Europe's finance ministers on the Greek fiscal crisis.
There is a smattering of U.S. economic data, including industrial production, consumer and producer inflation data, and the minutes of the Fed's last meeting. Earnings are expected from some major companies in the week ahead, including Wal-Mart, Hewlett Packard,Merck and Kraft.
Stocks in the past week seesawed, but finished higher for the first positive week in five. The Dow gained 86 points or 0.9 percent to 10099, while the S&P 500 rose 9 points, 0.9 percent, to 1075. Friday saw triple digit losses during the day, but the Dow ultimately finished down just 45 points. News that China was restricting bank lending to cool its economy, and continued concern about Greece weighed on the market.
"It's really jumpy. I think there's a lot of apprehension about the long weekend and what might come out of the Euro zone," said Daniel Deming, who trades with Stutland Equities at the Chicago Board Options Exchange.
"There's just so much offshore news that's influencing our market and the market has a difficult time getting a handle on it," he said. "... It's not fear, but I can say everybody's trading much more defensively right now. They're trying to protect against further volatility, instead of offensively like the market's going to sustain these levels."
The dollar was up 0.3 percent against the euro in the past week, to a level of $1.3618, and it gained 0.7 percent against the yen.
"For the euro next week, this is likely to be the final straw," said Brian Dolan of Forex.com. "(Euro zone finance ministers) are supposed to hash out some concrete proposals...What they are unlikely to do is pledge real concrete money to the Greeks. What they are likely to do is come out with a very heavy handed implementation plan of the Greek budget, and they'll revisit the issue at the end of March. That's when we have the most recent revenue and budget figures from the Greek government."
Dolan said the market is expecting Germany to take the lead with a financial rescue plan. "That doesn't seem to be politically feasible at the moment. The French and the Germans can't support it from the political side," he said. As a result, the euro could test a level of $1.35, before heading toward a support level of $1.3250 to $1.33 per dollar.
Dolan said he expects risk assets, stocks and commodities, to be in for a rough ride. "The real clincher for us is the stimulus efforts are done. They've worked their way through in Europe, the U.K., China as well. The U.S. is the one exception. Ours is going to keep contributing through the second half of the year," he said. "They've taken the training wheels off and we're going to see how good the rider has become."
Wells Fargo Advisors chief equity strategist Stuart Freeman also sees China's efforts to slow its economy as the sign of a coming change that world markets will adjust for. "This is the time in the cycle when you expect tightening in the world to begin, and we also had some news from the Fed that they're looking to take some of the liquidity back before they actually raise rates. We don't think they're going to raise rates any time soon. The news looks like it's going to be a relatively soft tightening period over all, as we work through the next eight to 12 months," he said.
The timing of China's announcement early Friday surprised markets. Just a day earlier, risk assets rose on the back of a tame Chinese inflation report. China's efforts to curb its rapid growth has been viewed as a double edged sword by traders, who want to see the country avoid a bubble economy but fear it could dampen the recovery of the global economy.
Traders have been debating for weeks now where the bottom will be in the current stock sell off. Deming, who trades the VIX, the CBOE's volatility index, said if the VIX cracks its 200-day moving average of 25.30 in the next week, it could spike to 30. "At that point I think we'd see the S and P test 1035, if not 1020," he said.
"It's (S and P) searching for a bottom here, but it just doesn't feel like it found it. It's trying to hold these levels...If we can somehow break 1080, I still think the high side over the short period is 1100," he said.
Brown Brothers Harriman investment strategist Andrew Burkly said he believes the market will continue to correct for awhile.
"We think we're in a 10 to 15 percent correction that will last three to four months. It will generally be backing and filling. There will be a little bounce back and forth but the trend is still lower," he said.
"We think this is going to last through most of the first half of the year...We have a 1200 target on the S&P, but we think in the near term dip, we make it down to 1000 or slightly below," said Burkly.
What to Watch Next Week
Freeman said the stock market is in the second stage of recovery. Trading will be more volatile, and its move higher will be bumpier and more gradual than the move since the March lows. Besides the pullback in stimulus, he expects earnings to become a factor affecting stocks as the now-easy comparisons end.
"Operating earnings are up 40 percent from the trough" in fourth quarter of 2008, he said. He noted that a lot of the gains were from cost cutting and there is still not much revenue growth.
Burkly too says he sees the market in an adjustment phase. "Fourth quarter numbers have been great. We have had 75 percent upside surprises but forward numbers are not rising as much as they were," he said.
He also sees the decline of stimulus as a negative factor for stocks, particularly the Fed's exit strategy, which was detailed by Fed Chairman Ben Bernanke in written testimony this past week. Bernanke indicated that one aspect of the plan is that the Fed will move to use the interest rates on reserves as an important monetary tool, over the Fed funds rate.
"I think the market is confused about what it means. It is not about the Fed raising rates. We do think they are going to go ahead with this plan to drain liquidity," Burkly said.
"2010 is going to see more volatility and much more muted upside potential. Our target for the S and P this year is in the 1175 to 1200 area. We got within 2 percent a month and a half ago. I think over the course of the year, we're still comfortable with that target but we're going to see volatility on both sides as we move through the year. This isn't going to be an up, up and away year for the market," Freeman said.
Freeman said it will be important to be a stock picker in this market, but there still should be some good sector plays.
"I think it's going to be one of those periods where you have, maybe a month of defensives doing well and a month of cyclical doing better and back and forth as we move through the year. I think net, net as we move out, you're going to find the ones that benefit from recovery are going to be the ones that perform the best," he said.
Burkly said he has shifted to a more defensive portfolio and is now favoring groups like health care. "We've been easing away from that super cyclical bias," he said. "There's some areas within staples that are looking better, like grocery stores and drug stores, and energy is still an areas we like. When we talk about earnings revisions, energy never had a big ramp up," he said.
What to Watch
Economic reports this week include the Producer Price Index on Thursday, and the Consumer Price Index on Friday. Minutes of the Fed's last meeting are released Wednesday afternoon and will be closely watched for the Fed's economic forecast and also what FOMC members had to say about unwinding the Fed's programs.
On Monday, there is also the Empire State survey and the Treasury's international capital flow data. Housing data in the coming week includes the National Association of Home Builders survey on Tuesday and housing starts on Wednesday. Weekly jobless claims and the Philadelphia Fed survey are released Thursday as is leading indicators for January.
Earnings news this week includes Merck , Kraft Foods , Qwest, Teva Pharmaceuticals, Waste Management, Whole Foods and Abercrombie and Fitch on Tuesday.
Hewlett-Packard , Genzyme, Martha Stewart, Questar, Chesapeake Energy and Priceline.com report Wednesday.
On Thursday, Wal-Mart reports in the morning, as does Barrick Gold, Daimler, DirecTV, Hormel Foods, Noble Energy, Williams Cos, and Apache Oil.
CBS and Dell report after the bell that day. J.C. Penney and PG&E report Friday.
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