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Look Ahead: Europe's Weekend Will Determine Wall Street's Week

The volatility that zapped stock prices in the past week could continue to deliver some jolts in the week ahead.

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Oliver Quilla for CNBC.com

U.S. markets will keep their focus on Europe, where EU officials on Saturday were working out the details of a financial support mechanism to prevent Greece's debt turmoil spreading to Portugal and Spain. It's hoped that the plan will be ready for approval by EU finance ministers on Sunday.

"The situation is clearly reaching crisis levels, and you don't need to be a genius to figure it out. I think that's what we're going to need to see them stabilize the financing market," said Barry Knapp of Barclays, before the Euro zone news.

Euro zone leaders approved an anticipated package of emergency loans for Greece late Friday.

Stocks had their worst week since just before the start of the market's 14-month rally in March of 2009. The Dow was down 4.7 percent at 10,380, and the S&P 500 fell 6.4 percent to 1110, sending the index slightly into negative territory for the year. The Nasdaq was nearly 8 percent lower at 2265. Energy stocks were the worst performers, down 7.9 percent, as crude oil declined 12.8 percent for the week to $75.11 per barrel. Gold, however, rose 10.4 percent to $1,210.40, in a flight-to-safety trade.

The worries about Greece and further contagion took a toll on the euro. The dollar gained nearly 5 percent in the past week against the euro, which was trading at $1.2731 Friday. The dollar, meanwhile, was down 2.8 percent against the yen but up 3.2 percent against the pound, as uncertainty about the U.K. election weighed on sterling.

"All I can say is if we can assume the European Central Bank does the rational thing, which is ease aggressively, it should be good for stocks. Ultimately, I think the market is going to continue to sell off until you have more clarity about what the European Central Bank is going to do," said Jason Trennert, chief investment strategist at Strategas Research.

French President Nicolas Sarkozy and German Chancellor Angela Merkel Friday evening (New York time) said the 16 euro zone nations would have a financial defense plan by the time markets open Monday to protect their currency. European finance ministers will hold another emergency meeting Sunday to work out specifics.

Merkel, meanwhile, faces political risk this weekend as voters in the region of Northern Rhine-Westphalia go to the polls Sunday. It is possible she could lose her majority as a result. Germany's parliament approved the Greek aid package Friday, despite its unpopularity with German citizens.

Traders Friday speculated that the Fed could make a weekend announcement as well, about extending swap lines to Europe.

The market's worst day in the past week was Thursday when the Dow took a near 1,000 point intraday plunge amid a still-unexplained series of trades in stocks and futures. The incident resulted in a batch of canceled trades on Nasdaq and electronic exchanges. The SEC and CFTC said late Friday they are throwing lots of resources behind investigating the situation and will make rule changes as necessary to prevent it from happening again.

What to Watch

In the coming week, there are some major earnings reports expected, including Disney , Cisco and retailers Macy's and JCPenney . Economic reports include retail sales and trade data. The Senate will also continue to work towards a financial regulatory reform bill.

The European Debt Crisis - See Complete Coverage
The European Debt Crisis - See Complete Coverage

"Events around Europe are first and foremost, followed by Treasury supply which has to be taken down in a volatile week, and retail sales," said Joseph LaVorgna, chief U.S. economist at Deutsche Bank.

The European sovereign debt crisis comes as U.S. economic and earnings news is increasingly positive and would have been a potential spring board for stocks. Friday's April employment report of 290,000 new non farm jobs was much better than the 180,000 anticipated by economists.

LaVorgna said he expects April retail sales to gain 0.2 percent, softer than last month when an early Easter and pent up demand sent consumers shopping. "Even a mild gain in April retail sales will show how the consumer is recovering and is healthier than we gave him or her credit for," said LaVorgna. As for jobs data, he said he is already penciling in a 475,000 non farm payroll gain for May, which would include 250,000 census jobs.

The week's economic reports include wholesale trade on Tuesday; international trade on Wednesday; weekly jobless claims and import prices on Thursday. Besides retail sales Friday, there is industrial production, consumer sentiment and business inventories.

"I'm kind of betting the U.S. economy will power through this," said Trennert. "I think (stock) valuations are such now that I think the risk reward is quite positive."

"The question among everybody here is, "Is Greece Bear Stearns or is it Dubai? Is it systemic or is it a kind of one off thing." My own visceral feeling is it's more of a one off type thing. I do think it's clear the U.S. stock market was due for some sort of consolidation, but I'm not convinced Greece was enough to short circuit what should be a pretty robust rebound into 2011," Trennert said.

Knapp said, as he watched Friday's 139 point Dow sell off, that it was interesting that the sectors leading the market lower were tech and industrials. "The two worst performing are tech and industrials. Financials are actually doing better. That makes no sense to me. What it implies is that's the stuff people are long and they're selling because they have to rather than they want to. It means we're closer to a low than a top," he said.

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Credit Re-Crunching

Credit Re-Crunching

The Treasury plans to auction a total $78 billion in 3- and 10-year notes, and 30-year bonds. In the past week as investors rushed to the safety of Treasurys, the 10-year yield moved sharply lower and broke below its recent range, of about 3.50 to 4 percent. On Friday, it touch 3.27 percent. "Now it looks like the range is going to be 3.25 or 3.30 to 3.75 in 10-year notes," said David Ader, chief Treasury strategist at CRT Capital.

"You take a look at what's happening now in spreads, Libor OIS, credit spreads are moving out...That was a big trade for people, and now they are going to start lightening up in that and that is going to provide a bid to Treasurys," Ader said. Spreads on everything from corporate to high-yield to mortgages all moved wider in the past week, sending a shudder through the equities market.

"What happened in the stock market is you have to sell..this is like 'get me out of risk assets' and the most liquid risk asset you can sell is a major stock index and that's the proxy," he said.

One of the big factors behind the market's sell off was the ripple effect from the Greek debt crisis on banks. There have been whispers of worry about European banks, which hold large amounts of European sovereign debt. As contagion fears spread among the euro zone's weakest members - Italy, Spain and Portugal - sovereign spreads widened and the fears about banks snowballed.

Knapp said he's watches the spreads on euro versus dollar cross currency swaps and in the past week they moved sharply lower.. "It underscores that there's a shortage of dollar-based financing for European banks. To me, that's how it washes to shore, so to speak," he said.

Analysts say U.S. banks have limited direct exposure to southern European sovereign debt, but the big unknown is what their counter party exposure might be to Europe's banks. For that reason, many on Wall Street likened the market events this week to shades of Lehman.

"The amount of currency swaps and interest rate swaps between U.S and European banks has to be humungous," said one credit expert.

Knapp said he's also watching the progress of financial regulatory reform because of its potential impact on banks. He said the "too big to fail" provision could result in higher short term borrowing costs for banks since Moody's and Standard and Poor's could cut their credit ratings.

What Else to Watch

Fed Chairman Ben Bernanke speaks in Philadelphia Thursday at 12:30 pm on community development. Fed Vice Chairman Donald Kohn speaks on monetary policy and lender of last resort in Ottawa that day, and Dallas Fed President Richard Fisher speaks at 1:15 in Odessa, Texas that day.

Other Fed speakers include Minneapolis Fed President Narayana Kocherlakota who speaks Monday on taxing risk in Minneapolis, and Atlanta Fed President Dennis Lockhart speaks in Atlanta Tuesday on the financial system after the crisis. Chicago Fed President Charles Evans speaks on Friday afternoon in Bloomington,Ill.

Companies reporting earnings include Dish Networks, Tyson Foods, Dean Foods and Priceline.com, all on Monday. Tuesday's reports include Disney and Toyota. Allianz, Macy's and Cisco report Wednesday. Kohl's, Urban Outfitters, Nordstrom and Nvidia report Thursday, and JCPenney reports Friday.

- Reuters contributed to this report.

Questions? Comments? Email us at marketinsider@cnbc.com