U.S. stocks may struggle to return to firmer footing this week if anti-government riots in Egypt destabilize the Middle East, keeping investors on edge.
Cautious trading could also come if earnings do not outperform and erode optimism about profits. The government's January jobs report on Friday will highlight the week's economic data.
Worries that Egypt's unrest could spread to other countries in the Middle East, home to the world's top oil exporters, caused investors on Friday to pull out of stocks and into bonds and other safer assets. U.S. crude futures settled more than 4 percent higher on Friday.
Market volatility skyrocketed on Friday as indexes tumbled and investors scrambled to hedge against further losses. The VIX index, the market's fear gauge, rose 24 percent, its biggest daily percentage jump since May 20.
By Sunday, more than 100 people had been killed in Egypt after five days of protesting the government of Hosni Mubarak. Protests in other nations has investors worried about destabilization in the region.
"I don't like this. It is spreading and contagion risk is rising," said David Kotok, chairman and chief investment officer at Cumberland Advisors in Sarasota, Florida.
Investors were also worried that an extended rise in oil prices could hurt global recovery. Analysts had been forecasting a pullback in the market for weeks, given the recent sharp gains, and said the Egypt news could be an excuse for some investors to sell.
"It could well turn out to be a short-lived correction, and it would be dangerous to try and time this thing," David Kelly, chief market strategist for JPMorgan Funds in New York, said, noting he has a long-term bullish outlook.
The Standard & Poor's 500 index is still up 18 percent since the start of September, roughly when the current rally began.
The Dow Jones industrial average snapped an eight-week streak of gains with Friday's close. The S&P 500 and Nasdaq also ended with losses for the week.
The Nasdaq fell more than 2 percent on Friday while the S&P and Dow both were down more than 1 percent.
Monday could see a bounce-back after Friday's losses, followed by more consolidation, said Matt McCormick, a portfolio manager at Cincinnati-based Bahl & Gaynor Inc, which has $3.2 billion in assets.
"My recommendation for clients is that if you have profits, especially in lower-quality names that have benefited from QE2 (quantitative easing), now is the time to take profits and look at blue chip names that haven't gained as much," he said.
Marshall Gause, CEO and chief investment officer at asset management firm Geneva Funds Partners in Denver, said worry about Egypt could cause the S&P to drop between 0.5 percent and 0.75 percent at Monday's open, but he said there was a "good possibility" of closing positive on the day.
Among key support levels traders are eyeing are 1,271 and 1,263 on the S&P 500, according to Craig Peskin, co-head of technical analysis research at MF Global in New York.
Optimism about fourth-quarter earnings helped lift stocks in recent weeks, but the latest batch of reports disappointed investors, including Ford Motor Co and Amazon.com .
The majority of companies continue to beat expectations, though, and analysts will watch to see if that trend holds. Of the 207 companies in the S&P 500 that have reported earnings, 71 percent have beaten analysts' expectations, according to Thomson Reuters data.
Next week, 102 S&P 500 companies are expected to report, including Dow Chemical Company and United Parcel Service.
"The earnings picture is still a good picture," Kelly said. "There were some disappointments today, but I don't think that really changes that."
He sees stronger earnings and an improving economy as the main factors benefiting stocks in the longer term.
The high U.S. unemployment rate has been the biggest problem for the economy. The rate fell in December to 9.4 percent from 9.8 percent the prior month, but economists see slow progress ahead for job gains.
Nevertheless, the U.S. economy is growing more rapidly. The Commerce Department reported Friday that gross domestic product rose at a solid 3.2 percent annual rate in the final three months of 2010.
But the bigger driver for stocks is likely to be Egypt, analysts said, given the uncertainty created in the market.
"The perception is that risk is elevated. Who knows how this ultimately will play out," said Paul Herber, a portfolio manager at Forward Frontier in San Francisco.
"This is something that began in Tunisia and now spread to Egypt. There are other countries in a very similar position. So people are taking money off the table and going to safe areas," he said.
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