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Investors Could Be in for More Stock Market Vertigo in Week Ahead

Big swings in stock prices could again characterize trading in the week ahead, as investors watch Europe and the very behavior of the markets themselves.

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Stocks had one of their most volatile weeks ever. The Dow Jones Industrial Average racked up four stomach-churning, 400-plus point moves, heading first sharply lower, then higher, then lower, and finally higher again. By Friday, stock market turbulence slowed, and the Dow gained a relatively small 125 points, or 1.1 percent. For the week, the Dow was down just 1.5 percent at 11,269 and it is now down 11 percent in three weeks.

In the coming week, there are economic reports on inflation and housing, as well as some major earnings - Hewlett-Packard and Wal-Mart . But the focus will again be on Europe's sovereign debt crisis, and traders are awaiting the Tuesday meeting between German Chancellor Angela Merkel and French President Nicolas Sarkozy.

"At first, the markets took this as an emergency meeting, when in fact the German government said it was scheduled weeks in advance," said Brian Dolan of Forex.com. "The fact they are getting together is good, to discuss what additional steps they can take to restore confidence in European debt markets. The key is that the ECB (European Central Bank) has already stepped in, and they are the only ones that could do something at this point."

The ECB purchased Italian and Spanish bonds this week, managing to bring down yields and stabilize the market. Even as the ECB worked to contain the crisis, unfounded rumors swirled mid-week about a credit downgrade of France and speculation about French banks sent markets into a tizzy. The debt purchases, a short selling ban in European markets, and perhaps overly optimistic expectations about the upcoming meeting between the leaders of Germany and France calmed things down.

"The focus will continue to be on Europe and measures it takes to ring fence problems to Portugal, Ireland and Greece," said Pimco senior strategist Tony Crescenzi.

"What we want to hear from them is how large the ESFS (bailout fund) is going to be - how big is the bazooka," he said. The fund currently is not considered to be large enough to solve all of Europe's potential sovereign problems.

Market Mayhem

The S&P 500, which had blasted through all sorts of technical levels, finished the week at 1171, a loss of 1.7 percent. The Nasdaq was down just under a percent, at 2507. Gold gained 4.4 percent to $1742, after a week of volatile trading that took it above $1800 an ounce. The dollar index was basically flat on the week, but the dollar was down more than 2 percent against the yen.

Investors rushed into U.S. Treasurys, seen as the safest of havens, despite the rating downgrade. The yield on the 10-year dipped to 2.03, but was at 2.257 at the end of the week. "Given the volatility of the last week and a half, I could see another run to the 2 percent level, and we could also see a backup to 2.50," on the 10-year, said CRT Capital senior Treasury strategist Ian Lyngen.

The S&P 500 plunged to as low as 1101 in the past week's violent trading. Bear market territory would be at 1090.89 on the S&P 500, 20 percent below the April closing high. RBS currency strategist Robert Sinche, in a note, points out that the S&P touched 1101.54 just below 1101.73, the 38.2 percent Fibonacci retracement of the entire rally since March, 2009.

Analysts expect the coming week to be marked with some of the same volatility. "Obviously, the volatility will calm down over the next couple of weeks. We've gotten past a lot of the uncertainty, but there's still the European situation that's hanging out there. It's kind of stabilized right now, but whether it blows up again over the weekend has yet to be seen," said Brad Sorensen, director of market and sector research at Charles Schwab.

"We are still relatively constructive on the market, going forward through the rest of 2011. Obviously, risks have grown, especially with the European situation and the downgrade of the United States. We think the markets overreacted to the downgrade and fears of a double dip recession. Most of the economic indicators are indicating growth, not stellar growth, but still growth," Sorensen said.

Investor Confidence Hit

Sorensen said some Schwab clients have been among those selling into the rocky market. "We continue to preach that equities investing for the vast majority of investors should not be viewed in the short-term...There's certainly an increase in fear. We've seen trading volumes go up, which we don't love to see, but we do have clients who have an advisor or have someone to counsel them off the ledge. They tend to stay pat and stick with their longer term investment plan. That's what we like to see, but fear has increased all over the market," said Sorensen.

J.P. Morgan chief U.S. equities strategist Thomas Lee said the experience of investors during the 2008 markets meltdown is affecting their behavior now, and he said some hedge funds have gone to cash. "Everyone's remembering 2008. That's why the Standard and Poor's action was like fire in a crowded theater. It was a very irresponsible thing to do. It basically caused markets to malfunction," he said. Standard and Poor's last Friday downgraded the U.S. AAA credit rating to AA plus, one notch lower. Moody's and Fitch said they were not yet taking action.

The downgrade came shortly after the resolution of the acrimonious battle in Congress over the extension of the U.S. debt ceiling. That public battle, the volatile stock market and growing pessimism about the economy may have combined to weigh on consumer sentiment, which on Friday was reported at 54.9, its lowest level in three decades.

In the coming week, President Obama takes an economic bus tour, starting in Minnesota.

"What got lost in a lot of this political mess is that we have a Q2 earnings season that was really good, and corporate balance sheets are solid. Of course, there's a risk confidence will crumble and demand falls apart," said Sorensen. "We still think that's not going to happen. We think that after we've gotten past these bumps in the road, we'll start to see a pickup...We're relatively bullish. We're even a little more bullish with these valuations."

FEARS OF A DOUBLE-DIP

Double Dip?

The fears of a double dip recession have been weighing on markets, and the Fed this past week, helped stoke markets concerns that the economy will crawl along for a very long time. For the first time, Fed officials put a time frame on how long their "extended period" to keep interest rates low will be, and that period is until mid-2013.

The Fed also signaled it was considering its options, immediately prompting market speculation that another quantitative easing program is in the offing. Fed Chairman Ben Bernanke speaks at the Fed's annual Jackson Hole meeting at the end of the month, and it was there last year that he first discussed the Treasury securities purchase program that became known as QE2.

"Jackson Hole was a pivotal point of the potential for QE2. Will this one be the pivotal point for a QE3?" said Lyngen. "The question is, is it bullish or bearish for the (bond) market."

Another question for markets now is whether the stock market's violent sell off has become such a negative for consumer and business confidence that it will impact the economy.

"I think it would be wrong to say there hasn't been damage. The market's been damaged for sure," said J.P. Morgan chief U.S. equities strategist Thomas Lee. "I think the chances of a recession are lower, but the odds of a bear market are one-in-three." Lee said if there was a bear market, it would most likely be short in duration, unless the economy did fall into recession again.

"I would say even though people are discounting it now., the U..S. economy is improving, improving so that the third quarter will look better than the second quarter," Lee said. The improvement in jobless claims to a four-month low of 395,000 in the past week was encouraging, but claims have to continue to improve, he said. Lee added that jobless claims were in fact a leading indicator in 2007, when the country was heading to recession. On the other hand, he said the stock market is a poor predictor of recessions, and was still rising as the country headed into the last recession.

Crescenzi also said he does not see an oncoming recession. "What defines a recession is a decrease in output and increase in unemployment. There's evidence that industrial production data in July increased," he said, noting that jobless claims are also improving. "Neither of those conditions suggest a recession." He said Japan's recovery from the earthquake and the pickup in auto production should be positives.

Econorama

Housing-related data in the coming week includes Monday's National Association of Home Builders survey; housing starts on Tuesday, and existing home sales on Thursday. Inflation data, the PPI, and the CPI are reported Wednesday and Thursday, respectively.

The Fed's senior loan officer survey and Treasury international capital flows data are released Monday, as is the regional Empire State survey.

Import prices and industrial production are reported Tuesday. Weekly jobless claims, the Philadelphia Fed survey and leading indicators are reported Thursday.

There are also several Fed speakers on the circuit, including Dallas Fed President Richard Fisher, one of three Fed officials who dissented at last week's meeting. He speaks Wednesday. Atlanta Fed President Dennis Lockhart speaks Monday.

Earnings Central

Hewlett-Packard, Dell and major retailers, Wal-mart and Home Depot report earnings in the coming week.

On Monday, Estee Lauder, Lowe's, Sysco and Agilent report. Wal-Mart, Home Depot, Saks and TJX report ahead of Tuesday's opening bell. Dell reports after the close that day.

Abercrombie and Fitch
, Target, Staples, PetSmart, Limited Brands and Chico's FAS report report Wednesday. Deere also reports.

Sears, The Buckle, Dollar tree, Gamestop and J.M. Smucker report before Thursday's closing bell. Hewlett-Packard, Gap, Footlocker, Intuit, Salesforce.com and Autodesk release results after Thursday's closing bell. Ann Inc reports on 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.

  • CNBC 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.