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Week Ahead: Market Will Be Watching Europe

Markets enter the week ahead slightly more optimistic that European leaders will finally show the resolve to address their sovereign debt crisis.

M. Lorden | Taxi | Getty Images

That doesn't mean a major solution will be announced, but analysts are more hopeful that the European Union's leaders two-day summit will end Friday with the promise of a more powerful plan to stop the spread of contagion and the threat to the global economy.

"I think the only thing that's really significantly impacting the equity and bond market here is what's going on over there, and whether it takes a tilt to the right or left depends on whether the right set of people come out of a door and start talking," said Stuart Freeman, chief equities strategist at Wells Fargo Advisors.

Santa Rally?

The stock marketgained more than 7 percent in the past week as the Fed, European Central Bankand four other central banks joined to extend swap lines and make dollar borrowing cheaper, alleviating some stress on European institutions. The S&P 500 rose 7.4 percent to 1244, its best weekly performance since March, 2009 The Dow gained 787 points, or 7 percent this week. That put the blue-chip index back in positive territory for the year — it's now up 3.8 percent for 2011. The Nasdaq gained 7.6 percent this week and the Russell 2000 jumped 10.3 percent.

And, the pros say, it may not be over yet.

"I think we could still get some lift from here," said Freeman. If Europe continues to make progress, stocks could see a "Santa Rally" as it gets closer to the end of the year and get some support into the start of the year when money goes into 401K plans and is allocated into the stock market, he said.

In the past week, European Central Bank President Mario Draghi signaled the ECB could do more to fight the sovereign debt crisisif European leaders move toward financial integration. By the end of the week, it appeared a solution involving the IMFplaying some type of administrative role was emerging. The IMF could also attract new funding to help Europe, giving emerging economies a bigger role in the process.

"There's a couple of things that look like they're hopefully coming into place. One is, there seems to be some realization by the ECB that they need to be an active participant in this even if it includes using the ECB balance sheet at some point," said Robert Sinche, chief global currency strategist at RBS. "There also seems to be a realization that the IMF has a role to play."

"Hopefully, they won't spend next Friday telling us what they can't do. I think the biggest change this week was they started telling us what they can do," said Sinche.

By the end of the week, some credit spreads narrowed and Italian bond yields, for instance, had receded back below 7 percent. The euro rose more than 1 percent for the week against the dollar, trading late Friday at 1.3387. Longer duration bond yieldsrose slightly in the U.S, with the 10-year Treasury at 2.046 percent late Friday.

"'Tis the season to keep positive momentum in motion," said George Goncalves, Nomura Americas Treasury strategist. "... I think behind the scenes, there's been a vote of confidence from the central banks. By doing these swap lines, it shows that they were willing to stand by the ECB 's side. That means something else has to be coming. They don't think the euro is going away. It's going to turn the tide of negativity."

Goncalves said he expects EU leaders to provide a framework of a plan. "I think it's an announcement of a plan that they're heading down the right track. They're all going to be giving up some of their sovereignty. They gave up monetary sovereignty 10 years ago, and now they're going to be giving up fiscal sovereignty — at a certain price."

He said the euro could decline on the news, if European leaders make progress, but that stocks would probably go higher, breaking the tight correlation between equities and the euro.

Another hurdle for markets is the expiration of the payroll tax cuts, which economists say would hurt growth next year if left to expire. "I think Congress gets their act together and passes it," Goncalves said. Another positive for stocks could be the Fed meeting if the Fed is particularly dovish.

"The market's itching to go up," he said. "I think we need to find stability and not have the negative fallout from Europe. If European leaders find a way to structure fiscal integration and If the ECB shows it is a willing lender of last resort, stocks would potentially benefit. "The big news for next year is the correlation is going to start to break."

What to Watch

There are a few U.S. economic reports in the coming week, including ISM services data and weekly jobless claims, but the biggest source of headlines for markets will be a series of meetings and events in Europe as officials work toward the summit. On Monday, German Chancellor Angela Merkel meets French President Nicolas Sarkozy to discuss the summit and how to strengthen stability rules to enable European institutions to intervene in national budgets.

U.S. Treasury Timothy Geithner will also be meeting with officials in Europe, and he meets Draghi, German Bundesbank President Jens Weidmann and German Finance Minister Wolfgang Schauble Tuesday. He meets with Sarkozy and French Finance Minister Francois Baroin Wednesday. He also meets Spanish Prime Minister-elect Mariano Rajoy Brey Wednesday, and then goes on to Milan Thursday to meet Italy's new leader, Mario Monti.

Monti on Monday submits his economic plan to the Italian parliament. Analysts expect it to be an austerity and growth package that contains some of the types of reforms that Germany and others have demanded. On Wednesday, the Greek parliament meets on budget cuts required to secure the next round of aid payments it needs to avoid default.

"I don't expect treaties or agreements to be signed next week, but at the minimum markets will be expecting detailed provisions (budget deficit limits, debt limits, surveillance and enforcement mechanisms and the like) to be spelled out and agreed to at the EU Summit on Friday," writes Brian Dolan of Forex.com. "... Even if they do reach agreement on concrete terms of tighter fiscal integration, markets may still not be persuaded and stresses could yet break out. If they fudge it again, get the helmets out."

Both the Bank of England and ECB hold rate meetings Thursday, and the ECB is widely expected to cut rates by 0.25 percent.

Markets Mayhem

At this time of year, analysts are writing up forecasts for the next year. Freeman said he has not come up with a firm number yet, but he expects to see a bit better than a five-percent gain. The market is now at the edge of his 2011 target of 1250 to 1300 for the S&P.

"It's very possible the greatest gains next year come at the back half," he said. "It isn't really about whether (Europe) goes into recession. The real question is what type of recession they have ... if they can control the bleed by the banks and get capital moving ... if they keep the banks from having serious problem, I think we'll be ok."

Freeman expects 2012 to bring continued volatility but a gradual resolution of Europe's problems could help. "Next year, we'll hopefully start to see some meat put on the bones of programs abroad and as that occurs, I think investors will feel better about things," he said. The U.S. presidential elections will also add to volatility, and the fourth year of a president's term is typically not a banner year for stocks.

"Historically that year is a five-percent year. I think it'll do a little better than that," he said.

As stocks roared back from the previous week's near five-percent losses, commodities also gained. Oil was helped by concerns about Iran, which was slapped with new economic sanctions by Western countries because of its nuclear program. Oil crossed back above $100 in the past week, gaining 4.3 percent to $100.96. RBOB gasoline was up 6.6 percent on the NYMEX to $2.6162 per gallon, lifted in part by news of another East Coast refinery shut down.

Econorama

Monday

1000 am ISM nonmanufacturing survey (Nov)

1000 am Factory orders (Oct)

1210 pm Chicago Fed President Charles Evans on the outlook

Tuesday

1000 am Fed Gov Daniel Tarullo at Senate Banking Committee

Wednesday

0300 pm Consumer credit (Oct)

Thursday

0700 am Bank of England rate announcement

0745 am European Central Bank rate announcement

0830 am Initial jobless claims

1000 am Wholesale trade (Oct)

Friday

EU Leaders Summit

0830 am International trade (Oct)

0955 am Consumer sentiment (Dec)

Follow Patti Domm on Twitter: @pattidomm

Disclaimer

  • 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.