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Stocks Primed for More Volatilty on Europe Woes

Sunday, 11 Sep 2011 01:22 PM

Investors will grapple with more turbulence surrounding Europe's deepening debt problems this week and the prospect of another round of dismal data on the faltering U.S. economy.

More volatility is almost guaranteed after the top German official at the European Central bank quit and rumors circulated throughout global markets that Greece will default this weekend. Greece later called the rumor market speculation designed to hurt the euro.

Recent market trading patterns and options activity also suggest August's roller-coaster ride will keep apace throughout September.

Juergen Stark's sudden resignation from the ECB on Friday came after a conflict over the bank's policy of buying government bonds to combat the euro zone's debt crisis, raising questions about a program that has been a key market stabilizer in recent months.

"You can tie our stock market directly to European banks -- the problem they have is sovereign debt exposure," said Jack de Gan, chief investment officer at Harbor Advisory Corp in Portsmouth, New Hampshire.

In a light week for earnings with only electronics retailer Best Buy Co Inc and diversified manufacturer Pall Corp among S&P 500 companies set to report, investors will eye a batch of data for any clues the economy has regained its footing. Economic readings over the past two months have left little reason for optimism.

But the euro zone, where a two-year sovereign debt crisis has unsettled investors worldwide, will be the real focus.

De Gan noted the ECB's critical role in potentially solving the sovereign debt issue, highlighting the implications for global markets on any reports of internal turmoil.

"Europe matters right now -- the ECB resignation, Trichet's keeping rates flat as opposed to outright cutting them," said Phil Orlando, chief equity market strategist, at Federated Investors in New York. "There are rumors I can't substantiate, but the rumors are still out there that this is the weekend Greece goes bust.

"So certainly, Europe is going to capture our attention," Orlando said.

A senior U.S. official, speaking after the close of the Group of Seven meeting in France, said there was no doubt European officials have the ability to cope with the issue and want to show markets they have the will to do so.

Data on tap for the coming week includes retail sales along with the consumer price and producer price indexes for August. Also expected are regional manufacturing surveys by the Philadelphia Federal Reserve Bank and by the New York Federal Reserve Bank, both of which showed contractions in factory activity last month.

Credit Suisse analyst Andrew Garthwaite boosted the probability of a mild recession to 25 percent from 20 percent, citing U.S growth concerns and poor political leadership in Europe. He lowered his 2011 target on the S&P 500 to 1,180 from 1,220, while also cutting his 2012 target to 1,260 from 1,300.

"Each bit of this data theoretically gets us down the road to understanding what the true state of the economy is. I expect overreaction to rule the day," said Kim Caughey Forrest, a senior equity research analyst at Fort Pitt Capital Group in Pittsburgh.

At the same time, the benchmark S&P 500 has been mired in a range of about 100 points -- between 1,120 and 1,220 -- for the past month, leaving the market susceptible to wide swings on a daily basis.

"We are just kind of in this nowhere zone," said Ken Polcari, managing director at ICAP Equities New York.

"We haven't broken through to the downside but nor have we broken it to the upside. So what you are going to continue to get is this erratic movement in the market until at some point, it's going to have break out one way or the other."

The continued rise in the CBOE Volatility index also points to large moves in the market. The index rose nearly 20 percent to top the 40 level for the first time since Aug. 26, indicating a rise in investor skittishness.

"I expect high volatility (this) week, big swings to the upside and downside. The VIX is quite high and pretty elevated," said Randy Frederick, director of trading and derivatives at Charles Schwab & Co in Austin, Texas.

"When the VIX is rising the way it is, that generally means the puts are going up too."

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