Thursday Look Ahead: Stocks Set to Close Out Best Quarter in a Year and Best September in 70 Years

Stocks are set to close out the third quarter with the best quarterly performance in a year, but traders are wondering what October will bring after September's record-setting performance and outsized moves in commodities, bonds and the dollar.

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The stock market drifted slightly lower Wednesday, with the Dow down 22 at 10,835 and the S&P 500 off 2 at 1144. The Dow is now up 10.9 percent for the quarter, and 8.2 percent for the month, its best September since 1939. For the S&P 500, its 9 percent monthly gain is the best since April, 2009 and its quarterly gain of 10.9 percent marks the best quarter in a year.

As stocks lifted off in September, so did commodities. The Thomson Reuters/CRB commodities index had its best September since it began in 1956. It was up 8.2 percent for the month, and 10.5 percent for the quarter. At the same time, bond yields fell, and the dollarweakened, with the dollar index losing 8.4 percent in the quarter and 4.3 percent for the month. But for the quarter, the dollar is higher against the euro.

That trend has been changing as September winds down, and its the dollar's decline that has been calling the tune for markets.

"The euro obviously is the highest it's been since April..I think that the ongoing story is there really isn't anything that can keep it from firming anymore. The dollar is kind of the winner of the ugliest contest and people are clearly content selling it because of the Fed's desire to press ahead with quantitative easing (QE)," said David Gilmore, strategist with Foreign Exchange Analytics.

The eurorose Wednesday even as strikes took place across Europe, Portugal discussed austerity plans, and traders continued to fret over Ireland and Spain's debt ratings. "Portugal's got issues right now. The opposition is not really on board with the new austerity measures. The Irish Prime minister is somewhat at risk. ..You have these very unpopular measures , no growth and you're stuck essentially with German and French monetary policy which isn't working....yet the euro keeps putting in new highs. I think the moral of the story is that QE trumps the debt crisis in Europe and does so decisively.

The other thing is we haven't heard a peep out of U.S. officials. Nobody has dragged out the strong dollar mantra," Gilmore said. The euro rose to $1.3629 Wednesday, an increase of 0.4 percent.

Gilmore said he expects to see the euro reach $1.40 in the next week or two, and the dollar index could decline about 10 percent in the next six months.

"It probably has a couple of quarters in it," Gilmore said of the dollar's drop. "It's got about six months to run before the U.S. economy gets any traction."

With the absence of U.S. data Wednesday, the markets continued to fixate on the idea of quantitative easing. Many Fed watchers believe the Fed would pursue further easing through the purchases of Treasury securities, after its November meeting.

In the bond market, some selling kicked in and some yields were higher on the day. The 10-year was yielding 2.5 percent in late afternoon but had slipped under 2.5 by evening.

Three Fed speakers got attention Wednesday, as they outwardly disagreed on new easing. Boston Fed President Eric Rosengren favored a new round of Treasury purchases, but Philadelphia Fed President Charles Plosser said he opposed asset purchases. Minneapolis Fed President Narayana Kocherlakota said the bond purchases would have little impact.

Yet, the markets have already moved, and traders continue to credit the Fed with driving down rates and the dollar.

"The market is trading a little tired. Yesterday, at the close, we met our target in the 10-years. I turned neutral on the market though I'm generally a long-term bull," said John Briggs, Treasury strategist at RBS.

Briggs said bonds could see buying through Thursday but may sell off once October comes. "I don't think it's going to sell off very hard, but I think the markets are fully priced for QE and the current information here. I think there's the possibility for people to switch into alternative assets" such as mortgages and asset-backed securities, he said.

Stocks also have gained support from the idea of new easing measures. "It could be they've (the Fed) injected some short term stability," said Patrick Kernan, who trades S&P 500 options at the CBOE.

Kernan said the market has been extremely quiet. "People have gotten a bit comfortable with slow drifts. Basically slow drifts (in stocks) cause complacency , and in the options world you see people who have no interest in owning options for protection or speculative purposes," he said.

"It definitely seems like people are comfortable with going along for the ride now....until it hits something in the tracks," said Kernan. He said October options imply low volatility.

"November volatility compared to October is significantly higher, implying that people are just kind of apathetic about the next few weeks going into October," he said.

What to Watch

The stock market continues to struggle with the 1148 level in the S&P, and it is an area to watch.

Art Cashin, UBS director of floor operations, said stocks keep challenging the 1150 level. "I'm sticking with exhaustion," said Cashin when asked why stocks moved lower in late trading.

"This is about the fifth try now and they haven't been able to break above it," he said.

Cashin said weekly jobless claims, released at 8:30 a.m., will be the last big important data item for the quarter. There is also revisions to second quarter GDP, at 8:30 a.m. and the Chicago Purchasing managers report, expected at 9:45 a.m. There is also a regional Kansas City Fed survey.

Investors will also be watching Congressional testimony from Fed Chairman Ben Bernanke, Securities and Exchange Commission Chair Mary Schapiro and FDIC Chair Sheila Bair, who appear before the Senate Banking committee at 10 a.m. on a hearing on implementing financial regulatory reform.

Washington Watch

The House of Representatives late Wednesday passed legislation by a wide margin that would seek trade sanctions against China and other nations for manipulating their currency to gain advantages for their exports. The future of the bill is unclear, since it is not expected to have an easy time in the Senate. But traders pointed to it as something that could worry the markets.

Bernanke also does a town hall with economic educators at 2:30 p.m.

- Follow me on Twitter @pattidomm.

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