Like an unpleasant relative, the European debt crisis came back for a visit Monday and may still be hanging around on Tuesday.
Important U.S. data this week will also get the markets' attention, as investors watch to see if fourth-quarter growth looks like it will meet the 2.5 percent of the third quarter. Tuesday's 10 a.m. release of ISM manufacturing data is a key reading of the manufacturing economy, and it is expected to be up slightly from last month at 52. Construction spending is also released at 10 a.m., and automakers will report sales throughout the day.
Tuesday is also the first day of the Fed's two-day meeting, where it is expected to discuss quantitative easing . Fed watchers are split on when and if the Fed would undertake another easing program. The speculation largely focuses on a new Fed program to buy mortgage securities, not Treasurys as it did in its so-called "QE2" program which ended in June.
The Dow fell sharply Mondayin its worse decline in a month, losing 2.3 percent to 11,955. But its 9.5 percent October gain was its best monthly gain since October, 2002. The S&P 500 lost 2.5 percent Monday to 1,253, but its 11.2 percent October gain gave it its best month since December, 1991.
Worry about the European debt situation was the main catalyst behind the decline, though the bankruptcy of MF Global, headed by former New Jersey Gov. Jon Corzine, added to the negative sentiment and contributed to the nearly 4 percent decline in financial stocks.
"I think the Europe situation is not resolved. There's all kinds of ways to look at pressure below the surface despite the euphoric (stock) market response" last week, said Marc Chandler, chief currency strategist at Brown Brothers Harriman.
Watching the euro was an obvious one of those, as it lost 2 percent Monday to 1.3859. Another measure was the Italian 10-year, yielding above 6 percent, as investors worry its government is not taking the idea of fiscal restraint seriously enough. "I don't think the whole thing is going to implode, but there's nothing that I see that's going to get Italy okay in the near future," said one trader.
The euro and stocks took a big leg down late in the day after a report quoted Greek Prime Minister George Papandreou saying he would put the new European Union agreement on financing Greece to a referendum. "What an unnecessary gamble and to do so just when the EU summit had put a lid on the crisis more or less. I realize that the wording of the referendum is critical and it could be far more benign and up the odds of a yes vote. But really how can the government call a referendum that does not explicitly put the Euro Zone membership at stake? It can't," wrote David Gilmore of FX Analytics in a note.
Chandler said Europe will stay in focus when it reports purchasing managers data Wednesday and service sector data Friday. "That's going to confirm that Europe is either in a recession or heading to a recession," he said. Chandler said the worries about Europe could be pushed off temporarily by positive comments from the G-20, which meets later in the week. He said the concerns could also fade a bit if China or Brazil make a deal to contribute to a special purpose vehicle to help the European bailout fund.
The Bank of Japan's intervention against the record high yen pushed that currency 3 percent lower against the dollar Monday. The yen move could have also sparked selling in the euro and other currencies, Chandler said.
What Else to Watch
There are a good number of earnings releases Tuesday. Pfizer, Archer Daniels Midland, Baker Hughes, CME Group, Credit Suisse, Thomson Reuters, Tenet Healthcare. Rowan Cos, Marathon Oil and Valero Energy report before the bell.
According to Thomson Reuters, 65 percent of the S&P 500 have reported earnings so far and 70 percent have beaten earnings estimates.
"Valuations look attractive, and one of the concerns, and rightfully so, was about the potential erosion of earnings," said Sam Stovall, chief equity strategist at S&P Capital IQ.
"In the middle of July, we thought third quarter (earnings) would be up 17 percent. By the middle of October, that forecast was whittled down to 12.5 percent, and now we are looking at 16.5 percent. Not only has the market experienced a V-shaped recovery, but so have third quarter earnings," Stovall said.
Traders are watching for further fallout from the bankruptcy of futures trading firm MF Global. Bank of Tokyo-Mitsubishi chief financial economist Chris Rupkey wrote in a note that MF was a case of "an excessive gunslinger market bet on Europe which went against every prudent risk rule in the book."
MF, which had about $40 billion in assets, had made an oversized bet on European debt. It filed bankruptcy Monday morning after failing to sell itself over the weekend. MF Global was also a primary dealer, which is a trading counterparty with the New York Fed, to help it implement monetary policy.
"The New York Fed has the primary dealers on a tight leash already," Rupkey wrote. "There will be a critical self-examination of the MF Global meltdown and whether there are lessons to be learned from this bankruptcy. This in some sense has become a classic run on the bank, where counterparties shy away from doing business with firms where questions are raised on financial solvency and capital. The biggest counterparty for dealers is the Fed and when they pull the plug, it is time to file for bankruptcy."
Rupkey expects the Fed to put dealers under more scrutiny. "It will be less fun than ever to be a primary Government securities dealer after MF Global. They will be watched like a hawk," he noted.
Follow Patti Domm on Twitter: @pattidomm