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Week Ahead: Choppy Market Will Try to Shrug Off Euro Worries

Stocks will navigate choppy waters in the week ahead, but could sail a bit more smoothly—barring any nasty, new surprises from Europe.

The quadruple expiration of futures and options Friday could add to volatility. The once rock steady energy sector will remain a focus, as President Obama meets with BP's chairman and CEO Wednesday on the still-unfolding Gulf oil disaster, and oil executives testify before Congress Tuesday and Thursday. Producer and consumer inflation data Wednesday and Thursday are the big economic reports of the week. FedEx , a barometer for the economic activity, reports earnings Wednesday.

Wall Street sign
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Wall Street sign

Traders are also keeping an eye on Europe, which is expected to be relatively quiet in the coming week but has delivered plenty of unexpected headline risk in recent weeks.

Jefferies Treasury strategist John Spinello said the markets show some signs of calming down. "The risk profile started changing in the middle of the (past) week with the stabilization of Europe and the stabilization of the stock market. You have stocks going up and the currency stable. It's going to be hard to get the fear trade into the (bond) market," said Spinello. Treasurys have been the big beneficiaries of market turbulence in a flight-to-safety trade. Yields rose at the end of the week, as those buyers stepped back.

Deutsche Bank's chief U.S. equities strategist Binky Chadha said the stock market's current choppiness is probably here to stay for now and could last about two months, if history is a guide. He said episodes of risk aversion have averaged 36 days, which would be mid-July, and that would be around the time when there is a heavy roll over of debt in Europe.

"That's a risk, and the market's going to remain jittery about that. We think generally earnings could be a trigger for a move up in the market, like it has in the last few earnings seasons," he said. "...If we're going to believe what the CEOs are saying, which is they're seeing limited impact from Europe, then earnings are going to surprise again."

Linked at the Dip

Chadha said there has been an interesting linkage between asset classes as the stock market corrected since early May. He said the correlation between stocks, bonds, credit, oil and currencies has never been higher and is at a record 65 percent. That correlation is measured by the proportion of variation in returns, and is now even higher than it was at its peak in late 2008, just after Lehman Brothers failed. Chadha said the correlation averages 30 percent.

"This is all asset classes. It's all basically the same trade, and so if the correlation across asset classes and stocks is so high, it's always important to look at valuation and what's happening to earnings, what's happening to multiples, but you don't want to emphasize that too much because what's happening is systemic, and it's across everything. It's basically a great de-risking," he said.

Chadha said unlike when Lehman Brothers failed, investors went into a "de-risking" mode just because of fear of an event, not an actual event.

"We've basically argued since the March bottom last year, that the market has basically been skeptical and we've spoken about how at some point, the market was just going to have a fit, and unfortunately, based on all the indicators that's exactly what's happening," he said.

Why Worry?

"This market moves up basically on proof, and right now we've got a whole set of concerns. There's the U.S. recovery, Washington regulatory risk. There's China slowing. The market is in need of proof on all these things to calm down. It's a pretty slow process. It usually takes a couple of months," Chadha said. " The market needs to check off all of the boxes before it goes back up."

Citigroup's Amitabh Arora, head of U.S. rates strategy, said he thinks markets will be calmer when there's an all-clear sign on European banks. Markets have been nervous about signs of stress in the interbank lending market and the health of Europe's banks in general because of their high exposure to European sovereign debt.

"To me the sovereign debt roll over is not the issue any more. It's the bank debt roll over. They have some cash on hand so they can fund it for some time, but there's no way they can meet six months of funding requirements entirely through internal accruals," he said.

"If you look at the CDS (credit default swaps) spreads on euro area banks, these are as large as they were at the time of the Lehman bankruptcy," Arora said, noting U.S. banks are much tighter. He did say there was some improvement in the past week. Bond investors use credit default swaps as insurance against default risk.

Arora said these concerns and others have put the flight-to-safety trade into Treasurys, which he thinks would be seeing higher yields on a fundamental basis. The 10-year was yielding 3.229 late Friday.

"There is a concern that growth is faltering, partly from loss of business confidence around Europe, a loss of business confidence around financial sector regulation, and uncertainties in the political environment. That's weighing on the market," he said.

"If euro area concerns blow over, we should see a 20 to 25 bps (basis points) backup in Treasury yields. We will need to see over the next three months no serious funding problems or unsecured borrowing issues for the banks, and then those are needed before it blows over," he said.

Arora said there is currently no specific scheduled roll over of bank debt on the horizon.

Oil Spill

The Dow finished its first week in three with a gain, ending up 2.8 percent at 10,211. The S&P 500 was up 2.5 percent to 1091. But these gains were in a week that saw extreme swings in both directions. The euro finished the week with a 1 percent gain against the dollar, at $1.2094.

Contract workers from BP load absorbent booms onto a boat before departing from a staging area to clean up oil impacted marshes  June 1, 2010 near Venice, Louisiana. Earlier in the day, U.S. President Barack Obama called the Deepwater Horizon accident the "greatest environmental disaster of its kind in our history."
Getty Images
Contract workers from BP load absorbent booms onto a boat before departing from a staging area to clean up oil impacted marshes  June 1, 2010 near Venice, Louisiana. Earlier in the day, U.S. President Barack Obama called the Deepwater Horizon accident the "greatest environmental disaster of its kind in our history."

Commodities were mostly higher for the week. Oil rose 3.2 percent to $73.78 per barrel, whilegold was also up on the week, up 1 percent at $1,230.20 per ounce

The S&P energy sector finished 5.1 percent higher on the week, and it was possibly the most volatile group. Shares rebounded Thursday and Friday but were pummeled earlier in the week as investors reacted to concerns BP and its partners could face unlimited liabilities and the industry could see new regulation. BP , Transocean and Anadarko saw their stocks plunge Wednesday, and even with sharp gains Thursday and Friday, they were among the week's losers. Anadarko was the worst performer in the S&P 500, down 7.4 percent.

According to reports, BP is expected to hold a board meeting Monday, where it will likely discuss the fate of its dividend. Over the weekend, President Obama was set to speak with British Prime Minister David Cameron about BP and the Gulf of Mexico situation.

Oil executives from Exxon , Chevron and Shell will appear before the House Energy and Commerce Committee Tuesday, and BP CEO Tony Hayward testifies before that committee Thursday. "I think the hearings next week will be a stage for the kind of political fury that's been spawned by this crisis, and what will affect the tone will be whether the current containment unit (on the rig) will be seen to be working by next week," said IHS CERA Chairman Daniel Yergin.

"The rest of the industry will go on record with the fact that the production in the Gulf of Mexico has been very safe. I think what's going to come out of this is that the whole system that was in place was really set up to deal with a tanker accident and what's needed for deep water in the Gulf—for production that produces 30 percent of U.S. oilis a safety system in place that works effectively when all other systems fail," said Yergin.

Econorama

Besides inflation data, Thursday's weekly jobless claims will be the number to watch after disappointing reports in the past couple of weeks. On Tuesday, there are import prices, the Empire State survey, and the Treasury's international capital flow data. The National Association of Home Builders releases its survey that afternoon. On Wednesday, there are housing starts and industrial production. Thursday's reports also include leading indicators and the Philadelphia Fed survey.

"I think the inflation data is worth watching," said Arora. "For so long, people have been concerned about inflation and I think only recently, at least in the U.S., people are turning to near term deflation concerns. Even in the Fed rhetoric there hasn't been much focus on it.

"The Fed hasn't had experience dealing with it. The one question to pose is what kind of policy options does the Fed have to deal with deflation," he said.

Forex.com's Brian Dolan said German and euro zone ZEW investor and business surveys are released Tuesday and should show a decline that will get the market's attention. He said he expects to see more euro weakness in the coming week, and the trend in general remains lower for risk assets.

"The world cup is going to be a bit of a drag," he said Friday afternoon. "Afternoons like this are going to be the norm for the next two weeks. Traders from London to Asia are just basically watching soccer games all day, every day so a lot of activity comes to a halt," he said.

There's just a smattering of earnings news in the week ahead. Besides FedEx, Best Buy reports Tuesday. Winnebago , JM Smucker , and Kroger report Thursday.

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

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