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Week Ahead: Markets at the Mercy of Washington and Europe

Europe and Washington could hold the key for financial markets in the week ahead.

"I don't think Ireland is bringing down the global economy. That's hard to believe... I think we have to separate a bit of sovereign Europe from corporate Europe. Corporate Europe looks pretty healthy. Corporate Europe is leading the world in terms of revenues and earnings surprises."" -Richard Bernstein Capital Management, Richard Bernstein

European finance ministers meet Monday and Tuesday as the Irish vote on their budget, a contingency for the Irish aid package. The Obama Administration and Congress, meanwhile, are expected to continue to move toward a compromise that would extend all of the Bush tax cuts for at least a year.

There is little economic data, but traders will focus on weekly jobless claims and any anecdotes on holiday shopping, to see whether the consumer will continue to spend or was just lured in by November sales.

Stocks in the past week gained 2.6 percent to 11,382, and the S&P 500 gained nearly 3 percent to 1224. The market ended Friday slightly higher, even as the November employment report showed a shockingly low increase in new jobs. There is deep concern that the disappointing jobs report is signaling a weaker fourth quarter than other economic data has been indicating.

Some traders Friday immediately embraced the idea that the Fed's controversial quantitative easing program is a necessity that will help fix the economy and keep juicing risk assets.

Bernanke Speaks

For that reason, investors will also be focused on Fed Chairman Ben Bernanke's comments on "60 Minutes" Sunday night although broadcast network CBS issued a press release with some highlights of his comments Friday, ahead of the market close. That release, which included no direct quotes, created a flurry that sent the euro to its highs of the day. The euro ended at about 1.3411, up more than 1.5 percent.

New York Stock Exchange, lower Manhattan, New York City.
Photo: Oliver Quillia for CNBC.com
New York Stock Exchange, lower Manhattan, New York City.

The CBS release said Bernanke, interviewed four days earlier, did not rule out more asset purchases beyond the $600 billion announced in November. However, the Fed has made said itself that it would be flexible with quantitative easing, based on economic conditions.

"They probably didn't appreciate the market's sensitivity to it. Bernanke isn't breaking any new ground. He didn't know the jobs number when he was interviewed," said Marc Chandler, head of foreign exchange strategy at Brown Brothers Harriman. Friday's jobs report showed a gain of just 39,000 non farm payrolls, compared to expectations for 149,000.

Euro Woe

Chandler said the first two days of the coming week could be important for the dollar. He said the Eurozone finance ministers meet amid rumors that they are going to increase the size of their bailout fund. "If they increase the size, people will say they're making space for Spain...but I don't think they will do it," he said.

Chandler expects a volatile couple of days for currency markets and based on the tightly correlated trade with equities, it may mean a volatile week for stocks.

"I think it's just not clear whether what's going on in Europe is going to get peoples' attention over the horrific U.S. jobs data and QE3 (expanded quantitative easing). Is that going to become a driver or will the developments in Europe be the driver?" he said.

The dollar and euro have been on a seesaw since the Fed first discussed quantitative easing plans in August. The dollar fell sharply on the idea of Fed easing, but rose relative to the euro when news around the sovereign crisis heated up. The Fed is buying Treasurys under its QE program, which in theory puts more money into the system and helps reflate asset prices.

More Debt

Quantitative easing was also expected to drive interest rates lower, but just the reverse has happened since the Fed embarked on its program. The 10-year ended Friday with a yield of 3.016 percent, its highest level since July 27.

Another big event traders are watching is the Treasury's issuance of $32 billion in 3-year notes; $21 billion in 10-year notes, and $13 billion in 30-year bonds in separate auctions Tuesday through Thursday.

"We'll just see how we digest (Treasury) supply next week. We'll see what happens in Europe, and we'll watch the (weekly jobless) claims number. The claims will be a real key thing for people to look at," said Deutsche Bank chief U.S. economist Joseph LaVorgna.

There's a relatively light schedule of economic reports. Besides the claims report Thursday, there is consumer credit on Tuesday. Wholesale trade is also reported Thursday, and international trade and import prices are reported Friday. Consumer sentiment is reported Friday.

LaVorgna said there's not much beyond the claims data that will make much difference to the economic picture. "The (employment) numbers are the numbers and the fact is they don't seem to jibe with the November labor data, but, hey, ultimately we care about the employment report and that's the report that matters most right now," he said.

"At the same time, the information is making me think the current quarter is not as good as we thought. It could be under 3 (percent growth) versus over 3," he said, adding he is not yet changing his forecast.

Where Stocks Are Headed Next

Whither Stocks?

Jefferies managing director Art Hogan said he expects to see some last minute shopping in the stock market, or "performance chasing" by fund managers who are seeking better returns before year end.

"Part of the conversation will be next week's gamesmanship about the extension of the tax cuts. That's about the most important thing we talk about next week, besides how does holiday shopping look," Hogan said.

Many analysts and traders expect a full extension of the tax cuts, and that would keep the maximum 15 percent rate for capital gains and dividends in place, a plus for stocks.

"Our data points on production are starting to heat up...right now 46 of 55 industries are experiencing improved capacity utilization rates. That doesn't sound very double-dippish to me. A year ago it was 11."" -Richard Bernstein Capital Management, Richard Bernstein

"I don't think it's priced in," said Hogan. "So I think the market goes up for not the least of reasons but that it takes a great deal of uncertainty out of corporate America's hands. You've got a catalyst." If all of the tax cuts don't get extended, he said it would be a negative catalyst.

Still Bullish

Richard Bernstein, CEO of Richard Bernstein Capital Management, said he expects to see economic data to continue to improve for the next six to nine months and that will help stocks. He also said he is looking at the longer trend of jobs data.

Bernstein has favored small cap stocks and continues to see them making gains, as long as the economic data improves. "They will continue to outperform for that time period at least. It's not like you're seeing a flood of capital into small cap companies," he said.

He said U.S. stocks are likely to surprise on the upside next year, and he thinks emerging markets will disappoint. Europe may also be more positive than expected.

"I don't think Ireland is bringing down the global economy. That's hard to believe...I think we have to separate a bit of sovereign Europe from corporate Europe. Corporate Europe looks pretty healthy. Corporate Europe is leading the world in terms of revenues and earnings surprises. For Europe as a whole, that even includes the financial companies. Corporate Europe is at least doing well," he said.

"I think the emerging markets are going to disappoint next year...Roughly 40 percent of emerging markets companies reported negative earnings surprises in the last reporting period. The U.S. were 70 percent positive, 20 percent negative. It was roughly double the rate of negative surprises in the United States and their values are quite lofty as expectations are very high," he said.

Bernstein has also liked Treasurys but he has recently changed his positioning. "We haven't pared the weighting of Treasurys. We have shortened the duration pretty dramatically. We're at the place in the cycle where you have upward pressure on longer-term interest rates...It's simply because the economy is getting better," he said.

He also likes stock sectors that reflect recovery.

Traders work on the floor of the New York Stock Exchange.
Getty Images
Traders work on the floor of the New York Stock Exchange.

"We are overweight energy and materials. That's reasonably new for us. The reason why is we believe we're actually heading into the early stages of the mid-phase of the economic cycle. Why do we say that? Our data points on production are starting to heat up...right now 46 of 55 industries are experiencing improved capacity utilization rates. That doesn't sound very double-dippish to me. A year ago it was 11," he said.

Bernstein said he thinks the market has far to run, though he doesn't provide targets. "The market is up more than 80 percent off its trough, and it's amazing to say we're still in the early phase of the bull market. The early phase of the bull market is always characterized by doubts. It can't happen and won't happen and certainly won't continue. And I think that's where we are," Bernstein said.

Notable quarterly earnings reports next week include Dollar General, AutoZone, H&R Block, Costco and National Semiconductor.

- Follow me on Twitter @pattidomm.

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.

  • CNBC Senior Commodities Correspondent and Personal Finance Correspondent

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

  • Rick Santelli joined CNBC Business News as an on-air editor in 1999, reporting live from the floor of the Chicago Board of Trade.

  • Senior Producer at CNBC's Breaking News Desk.