Traders expect more stomach-churning volatility in the week ahead, as investors fret about Europe and adjust their portfolios for quarter's end.
World stock markets and commodities took a stinging hit in the past week as fears of a double-dip recession gripped world markets and European leaders failed to show they were on a convincing path to stem their sovereign debt crisis. The Dow plunged 6.4 percentto 10,771, in its worst weekly loss since the weeks following Lehman's failure.
Gold tumbled 10 percentand silver crashed, losing 26 percent on the week. The dollar rose more than 2 percent and Treasurys saw record low yields, with the 10-year touching 1.67 percent, the lowest yield in recorded history.
In the coming week, there is a string of U.S. economic reports that will help shed light on housing and on the health and attitude of the consumer. But it's the headlines from Europe that will likely have the most ability to drive markets either way.
The so-called troika — the IMF, European Central Bank and EU — continue to consult with Greece on its efforts to secure the next tranche of funding that would help it stave off default. Greek Prime Minister George Papandreou meets with German Chancellor Angela Merkel in Berlin Tuesday.
"The short term-ism is just blowing people away," said BlackRock vice chairman Robert Doll, noting investors are too worried about the moment-by-moment developments that are rocking markets. "The risk of a European bust is not zero ... I'm going to say there's a one-out-of-three chance that it's unpleasant. Two-out-of three, you should be buying stocks with both hands and feet right now."
"If it doesn't have a nasty ending, I think we avoid a recession. If Europe has a nasty ending, I think that will push us into recession. Right now, we're still not in recession ... A lot of the CEOs we talk to say their business is okay," Doll said.
G-20 officials are in Washington for the IMF meetings over the weekend, but the markets were expecting little in the way of promising developments on Europe despite market chatter that Europe is planning to recapitalize banks. A number of European countries, including Germany, also vote in the coming week on enhancements to the 440 billion euro (US$591 billion) European Financial Stability Facility, which must be approved by all 17 countries.
Washington may also keep markets unsettled. Late Friday, the House and Senate were still at an impasse over a bill that would keep the government open after Sept. 30 and provide natural disaster victims relief.
Worries about a double-dip recession came roaring back mid-week when the Fed said in its post-meeting statement that the risks to the economy are "significant" and it noted "strains in global financial markets" could be a catalyst. The Fed's statement came the same day as a preliminary China manufacturing report showed moderating growth.
The Fed also announced its much-anticipated "Operation Twist," under which it plans to trade out of $400 billion shorter duration Treasury securities and into the same amount in 6- to 30-year bonds. In theory that should hold down rates and push investors into riskier assets, but the sell off in risk assets came on the heels of the worse-than-expected comment about the economy and the fears that "twist" will do little to help.
"I think Europe is the biggest downside risk to the U.S. right now. It's not the case that we have lots of excessive optimism in our economy like you usually do before a recession ... It's hard to make that case now that the level of housing sales or the level of auto sales or business expenditures are at excessive levels," said Dean Maki, Barclays Capital chief U.S. economist.
"If it comes, it will be more likely driven from events elsewhere. The big risk would be if the financial markets distress becomes so intense that you have consumers and businesses become paralyzed the way they did in late 2008," said Maki. He said consumers are not frozen but corporations have been frozen when it comes to hiring.
In the coming week's data, Maki said he is most interested in Friday's consumer-spending report. "We got off to a good start on real spending in July for the quarter ... August looks soft, and the question is just how soft is it. We're looking for a 0.3 [percent] rise in nominal consumer spending, which we think translates to a flat reading on real spending. That would put us on pace for a 2 percent annualized spending quarter," he said.
The week ahead also ends with the final days of the third quarter, which was a particularly rocky time for stocks. The Dow is down 13.5 percent for the quarter so far, and more than 7 percent for the year-to-date. The S&P 500, down 6.5 percent this past week to 1136, is down nearly 14 percent for the third quarter and just under 10 percent for the year.
"I would say the majority of the action we've seen in the last several weeks has been much more in the liquidation mode than the shoring up of positions. If there's any end of quarter action, I would expect it to be more liquidation," said Art Hogan of Lazard Capital Markets. "But there's probably a larger danger of a news reaction to the upside versus the downside."
By Friday, the selling frenzy of the past week slowed and stocks ended the day just slightly higher, with two winners for every loser. The Nasdaq was the best performer, up 1.1 percent on the day to 2483, as tech shares helped lead the gains.
Traders are watching the 1101 area on the S&P 500, which was the intraday low in August and a level that could determine whether stocks hold on or take another leg down. Some traders are looking for a moment of capitulation and expect it after the market takes another run at the recent lows. There was also some chatter that the market could see a decent relief rally after the next big selling bout.
The coming week is also the period before third-quarter earnings when companies could warn about profit misses, but so far there have not been all that many negatives. "Expectations are not real high. I think the feature (this earnings period) will be what analysts do with their crazy 2012 estimates. They have to come down. The question is: Do they use the Q3 earnings reports to bring down 2012?" Doll said.
Doll said he's picking stocks for their good cash flow and solid balance sheets over particular sectors, but he says that many of the companies he likes now happen to be in the tech and health-care sectors. He expects the market to settle down when the issues around Greece are resolved, but the timeline on that is uncertain.
Markets will also be watching the outcome of three Treasury auctions Tuesday through Thursday for $99 billion in 2-year, 5-year and 7-year notes. There is also high interest in Italian bond auctions, starting Tuesday.
Fed Chairman Ben Bernanke speaks at a Cleveland Clinic speakers series event Wednesday evening on lessons from emerging market economies on the sources of sustained growth. Fed Gov. Sarah Bloom Raskin speaks Monday morning at the University of Maryland Smith School of Business on monetary policy and job creation.
Here's the economic calendar for the week (All times are EDT):
10:00 am New-home sales
10:30 am Dallas Fed survey
09:00 am S&P Case-Shiller home prices
10:00 am Consumer confidence
10:00 am Richmond Fed survey
08:30 am Durable goods
08:30 am Weekly jobless claims
08:30 am Q2 GDP (final)
10:00 am Pending home sales
11:00 am Kansas City Fed survey
08:30 am Personal income/spending
09:45 am Chicago PMI
09:55 am Consumer sentiment
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