Market Insider

Europe Casts Shadow on Stock Market's Big Quarterly Gains

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The Dow is on track for its best first quarter gain in 15 years, and the S&P 500 is within reach of its all-time closing high.

But it will be Europe that could decide how investors close the books in the first quarter Thursday. Cyprus is set to reopen its banks for the first time in nearly two weeks, and traders will be watching for headlines from there and other parts of the euro zone. European officials have tried to ring fence Cyprus as a special case, not to be repeated, but investors are watching carefully to see what the impact of capital controls will be on the small country – and on banks.

U.S. stocks and other risk markets were rocked Wednesday by a sharp selloff in the euro. The euro broke below 1.28 for the first time since November, after it appeared Italy could not form a government without another election. European stock markets traded lower, and peripheral sovereign yields rose.

By the end of Wall Street trading, U.S. stocks stabilized , well off their lows. The S&P 500, down nearly one, was still just three points away from its closing high, and the Dow was off just 33 points at 14,526. Treasurys, impacted by quarter-end buying, moved higher and yields fell. The 10-year was yielding 1.84, off its overnight high of 1.92 percent.

The Dow is up about 10.9 percent for the first quarter, its best first quarter performance since the 11.3 percent gain in 1998. The Dow Transports jumped more than 16 percent, setting up for the best quarterly gain since 1991. The S&P 500 was up 9.6 percent, and the Nasdaq was up 7.9 percent. The S&P health care sector outperformed with a 14 percent gain, followed by consumer staples, up 13 percent. Materials and tech were the laggards, each up just over three percent.

(Read More: Bulls Revved Up to Take Out Next Milestone for Stocks)

Treasurys close early, at 1 p.m. Thursday, ahead of the Good Friday holiday when markets will be closed. The government auctions $29 billion in 7-year notes at 11:30 a.m. ET.

"If you could tell me what headlines come out of Cyprus or Malta or Slovenia or Italy, then I could probably make a good guess on the market, but failing that…we're probably going to be here for a while at these (yield) levels," said Harvey Goldsmith, Cantor Fitzgerald Treasury strategist.

Steve Massocca of Wedbush Securities said the stock market stabilized after Wednesday's morning selloff because Cyprus is not the threat for markets that problems another country would be. With an oversized banking system, tiny Cyprus restructured its failing banks, closing one, so it could qualify for a 10 billion euro bailout. The country extracted funds from uninsured depositors but also imposed strict capital controls, out of concern about runs on its banks.

"The world's going to move on," said Massocca. "It was not a situation where the European Central Bank had to 'do whatever it takes' so they didn't. If this happened in Spain or Italy, it's going to be an entirely different response."

Massocca said it would not be surprising to see the market start to sell off in the second quarter. "It's clearly a seasonal slowdown that happens. Most of the gains take place in the period prior to May, and it's happening again this year. Whether we get a significant decline, I don't know, but I think as we go into summer, things will feel heavier," he said.

The risks for stocks include weaker earnings, or a more serious flare up in Europe.

(Read More: Monetary Policy Is Not Loose Enough: Fed Official)

Serious Firepower Protects Cyprus Cash

What to Watch

Thursday's data includes weekly jobless claims and the final look at fourth quarter GDP at 8:30 a.m. Chicago PMI is at 9:45 a.m.

Jobless claims are expected at 340,000, the same as last week. "To me, it (claims) has been sending the signal for a while that the job market is getting better. The 350,000 level is the key threshold," said Joseph LaVorgna, chief U.S. economist at Deutsche Bank. "If we would get there for a sustained move below that 350,000, we need about eight weeks there, that is typically a game changer for the labor market."

"If over the next three or four months, we print the numbers I think we're going to print, the Fed is going to change its tune. Right now the Fed comments are dovish and that's probably because they are uncertain about what they've seen over the last few months and is it going to be sustained," he said.

Fed speakers were out in force Wednesday. "I just think the statements by the Fed officials all kind of reaffirmed relatively old positions with nothing much in the way of surprise," said Goldsmith. "Except it was quite an offensive for them toward re-establishing that the majority of voters…are going to continue to support quantitative easing, until they see what is now being defined as substantial improvement in the job market."

(Read More: Monetary Policy Is Not Loose Enough: Fed Official)

Chicago Fed President Charles Evans, in comments to reporters, reiterated that he would like to see job growth of 200,000 for six months before changing the QE program, which now involves the purchase of $85 billion in mortgage and Treasury securities each month.

Fed officials have signaled that the program could be tapered off if it appears that employment and the outlook are improving.

Simon Potter, who heads the Markets Group at the New York Fed, also was speaking Wednesday. He was quoted as saying the Fed asset purchases are being handled well by the markets, and the Fed has room to expand its mortgage purchases if needed. He said it is currently buying about half the gross issuance of mortgage-backed securities and a quarter of the monthly gross issuance of coupon Treasury securities.

Besides the data Thursday, there are several earnings including Blackberry, Mosaic, Accenture, Signet Jewelers, Winnebago and Gamestop.

Pinnacle Foods also begins trading Thursday on the NYSE, under the symbol PF. The food company, which makes Log Cabin syrup and Vlasic pickles, priced at the high end of the range at $20.