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Week Ahead: Traders look for clarity from China, Fed

Stocks start the week on a nervous footing, with traders looking for signals from both China and the Fed to turn the tide.

While stocks could see a reflex pop after last week's nearly six percent decline in the S&P 500, traders see the potential for the first double digit decline in the S&P in four years and a possible rocky period ahead.

S&P/Capital IQ strategist Sam Stovall said the S&P 500, in fact, could see its first negative year since 2011, if it does fall into a true correction of 10 percent or more.

"Should the S&P slip into a long overdue correction mode, it will likely take longer than year end to get back to break even," said Stovall. In 2011, the S&P was just very slightly lower, down much less than 1 percent. Before that it was last lower in 2008. As of now, it is down 4.3 percent for the year.

Markets have been spooked by a slowing China and traders are watching for signs of further stimulus from China as well as clarity from the Fed on whether a September rate hike is still possible.


Traders on the floor of the New York Stock Exchange.
Brendan McDermid | Reuters
Traders on the floor of the New York Stock Exchange.

"China's the big one. They've got to step in and do something. I think the Fed is an issue but it's not the biggest deal. They're damned if they do, damned if they don't," said Robert Doll, Nuveen Asset Management chief equity strategist and senior portfolio manager.

China Sunday allowed pension funds managed by local governments to invest in its stock market for the first time. Shanghai stocks were down nearly 12 percent last week. The Wall Street Journal also reported that China is planning to announce more steps to add liquidity to banks in the next several weeks, including cutting the deposits banks are required to keep in reserve.

Stocks fell Friday in a second day of heavy selling, with the Dow's 530-point drop the biggest one-day decline in four years. That index is now in a 10 percent correction for the first time since October 2011. The S&P 500 also fell sharply, blasting through key support levels to 1970, for a one-week decline of 5.8 percent. It is now 7.7 percent off its May highs.

Markets have been worried that China's will weaken further, and the ripple effects will continue to spread into other emerging markets and commodities. Emerging market currencies were lower in Asian trading early Monday, after a sharp drop in the past week. The Mexican peso last week was down 3.8 percent, the Malaysian ringgit was down 2.6, and the Russian ruble was down 6.6 percent, to name a few. Those markets have also been hit hard by the prospect of a rising dollar and higher U.S. rates, which would also be a setback for commodities and their currencies.

U.S. stock futures were lower Sunday. Since Tuesday, the S&P 500 fell about 130 points, with 64 of those points on Friday alone. Selling accelerated Wednesday, after the Fed released the minutes of its last meeting. The markets took those minutes as dovish and immediately began pricing out a rate hike for September, even though the Fed indicated it was still undecided at its July meeting. Traders say the next downside target for the S&P 500 is now around 1950.

While stocks were slammed in the past week, buyers moved into Treasurys, but the move in bond yields did not keep pace with the sharp sell off in stocks.

Nomura rate strategist George Goncalves says bonds are not yet exhibiting a big flight to quality trade.

"I think the bond market into the end of next week is going to operate on its own devices. There are some technical things with the end of the month. It's also the end of the summer…People don't want to get involved at these levels," said Goncalves.

Goncalves said Nomura expects the Fed to tighten in December but the odds of 2016 are rising, and the odds of September are waning.

"You need another day or two of this volatility for people to throw in the towel," he said. It would take another big swoosh down in stocks for a major flight to quality trade to come into the Treasury market. "If financial conditions continue to worsen, driving equity declines and credit widen, then the market is doing the tightening for the Fed."

Goncalves said market expectations for action by China may be too high. "There are a lot of things the Chinese could do but not in the short run. We're talking about an area of the world that has a slowing economy. Their equities market has been volatile and now they've changed their FX regime. They're doing a lot. We can't fault the Chinese for not trying to arrest these market changes. I think that it has to get worse for them to do more," he said.

Read MoreS&P strategist: Possible negative year for stocks

Yields move inversely to prices, and the yield on the 10-year yield was at 2.04 percent late Friday.

Oil futures were trading lower Sunday night, after eight weeks of declines, the longest weekly losing streak since 1986. West Texas Intermediate futures temporarily fell below $40 per barrel Friday but closed at $40.45 per barrel. WTI was down 4.8 percent for the week. The VIX, the CBOE's fear index based on put and calls in the S&P 500, shot up to 28.03 Friday, a 47 percent jump in one day.

"It's hard to know how much of the (S&P) decline, at the end of the day, was options expiration," said Peter Boockvar, chief market strategist at Lindsey Group. "You have a Friday in the summer where nobody's going to understand what's going to happen Sunday night in China. The market is worried about global growth." Traders speculated the Chinese government would intervene with a liquidity injection or some other stimulus. The Shanghai market, falling for weeks, was down more than 4 percent Friday after a weak Chinese manufacturing report.

Boockvar said stocks reflect both softer global growth and shrinking U.S. corporate earnings growth. "The market is adjusting to this…. The fundamental story for the U.S. market has changed because of the Fed, the end of QE (quantitative easing) and the potential rise in interest rates. The major tailwinds over the last couple of years has become headwinds. I think this correction is the beginning of something more. Could we have violent rally? Sure, but we could also be on the cusp of a bear market. This bull market has gone on for six years. People should be more worried about playing defense than picking bottoms," said Boockvar.

But Doll expects the market to come through the downturn and react much like it has after all of the pullbacks since the bull market began. "I think the selloff is more than half way in terms of points, but less than halfway in terms of time," said Doll.

Jonathan Golub, chief U.S. market strategist at RBC Capital Markets, said the market focus will really be on the markets in the week ahead. "Do I think there will be some government officials around the world who speak and that become news headlines? Yeah, but the market becomes its own story," he said. "What we will be talking about in the absence of a big data week and because we're not in earnings season, is really going to be where the dollar is, oil, volatility and the 10-year and that interaction is going to basically dominate what happens to the market. That's going to be far more important than what happens at the company level," said Golub.

Economists polled by CNBC mostly still believe the Fed will raise rates in September, even though the market now expects it to be later. There are several Fed speakers in the week ahead and the important Jackson Hole, Wyoming, Fed symposium begins Thursday. Fed Chair Janet Yellen is not attending the conference, but Fed Vice Chairman Stanley Fischer is attending, and he speaks Saturday.

Ahead of that, New York Fed President William Dudley, viewed as closely allied to Yellen, speaks on the regional economy Wednesday, but he will take questions from the media. Atlanta Fed President Dennis Lockhart speaks Monday, and his recent comments have been viewed as hawkish since he said he saw no reason for the Fed not to raise rates in September.

There is some important data in the week ahead, with the most important release the personal income and spending data Friday. There is also the revision to second quarter GDP on Thursday and economists expect growth to increase to 3.4 percent.

What to watch

Monday

9:45 a.m.: Manufacturing PMI

3:55 p.m.: Atlanta Fed President Dennis Lockhart

Tuesday

9 a.m.: S&P/Case-Shiller home prices, FHFA home prices

10 a.m.: New home sales, Consumer confidence

1 p.m.: $26 billion 2-year note auction

Wednesday

8:30 a.m.: Durable goods

9:45 a.m.: Services PMI

10 a.m.: New York Fed President Dudley on regional economy, Q&A

1 p.m.: $35 billion 5-year note auction

Thursday

Jackson Hole Fed symposium begins

8:30 a.m.: Initial claims

8:30 a.m.: Real GDP Q2 (second)

10 a.m.: Pending home sales

1 p.m.: $29 billion 7-year note auction

Friday

8:30 a.m.: Personal income

10 a.m.: Consumer sentiment

Saturday

12:25 p.m.: Fed Vice Chairman Stanley Fischer at Jackson Hole; topic U.S. inflation

--updates with correct name of Jonathan Golub's firm