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Stocks see new wall of worry after Paris attacks

Patti Domm
Getty Images. Investors should prepare for a down year next year for two reasons, chief market analyst at The Lindsey Group says.

The terror attacks in Paris are expected to spur a flight-to-safety trade this week, in markets that are already risk averse.

The coordinated attacks, which left more than 100 dead and hundreds others injured, prompted French President Francois to order new air strikes in Syria. On Sunday, French bombers strafed a Syrian stronghold of ISIS, which has claimed responsibility for the attacks.

Analysts said the environment should play into the hands of traditional safe-haven assets.

Read More France hammers ISIS stronghold in air strike

"Obviously this is an incredible tragedy, and you have a heightened sense of insecurity by investors and people around the world and when that happens you have a flight to safety. You should have a run on an already strong dollar," said Art Hogan, chief market strategist at Wunderlich Securities. Hogan expects continued selling in stocks and a bid in Treasurys.

"The markets were heading into a trade of consolidation. We were worried about an ongoing collapse in commodities markets caused by a stronger U.S. dollar and concerns about the pace of the global economy," Hogan added. "The big concerns are how strong does the dollar get and what does that hurt, including commodities."

ISIS also claimed responsibility for two other incidents in the last two weeks, including bombings in Beirut and the downing of Russian airliner over Egypt.

In the past week, U.S. crude (New York Mercantile Exchange: @CL.14) futures plummeted 8 percent, and that weighed on equities with the energy sector sliding 6 percent. The broader market also got pounded, with the S&P 500 Index (CME:Index and Options Market: .INX) down 3.6 percent to 2,023, its worst weekly performance since August 21.

Energy analyst John Kilduff of Again Capital said oil could fall further after the French attacks, since there could be a broader spillover effect on the economy.

"I'm expecting a substantial sell off here," said Kilduff. "Because this is going to disruptive for the economy especially in Europe, it's going to be negative for oil. This is ultimately going to push oil prices down further despite the escalation in the war on ISIS in the Syria region."

West Texas Intermediate (New York Mercantile Exchange: @CL.1) crude oil futures settled Friday afternoon at $40.74 per barrel, and analysts expect a retest of the $37.75 low set in late August.

The dollar (New York Board of Trade (Futures): =USD) is expected to continue its rise, particularly against the euro and analysts were already discussing Sunday how the incident could accelerate the move in the euro toward parity with the dollar.

"I think the interesting aspect is to see the dollar's behavior. We already anticipate the ECB (European Central Bank) is going to extend quantitative easing," said David Ader, head of treasury strategy at CRT Capital. The Paris attack hurts confidence and could enhance the prospects of easing even further, and that in turn could add to the euro's decline, he said.

As for Treasurys (U.S.:US10Y), he expects yields to continue lower as investors look for safety. Yields move inversely to price. "They're already doing something unusual. We already have a counter intuitive direction going on in the Treasury market and I think it's going to enhance something that was already taking place," he said.

Ader said yields have been moving lower in reaction to the sell off in stocks. Risk assets have been reacting to the drop in oil, as well as the prospect of the Federal Reserve hiking rates in December. He does not expect the Fed to change course, however, and the central bank still likely to raise rates in December.

"You can't rule out the Fed being moved, but I think at this stage of the game…there has to be a lot going on and it has to be on the domestic front to get them to shift," he said.

Read More Paris attacks leave 140 dead

Strategists have been expecting a brief pullback for stocks, and some expect any downturn to be followed by a Santa rally into the new year. Traders point to some of the technical damage done in the past week, with Apple down more than 7 percent after the stock gapped lower early in the week. The S&P broke through both its 200-day and 100-day moving averages Thursday and Friday.

"A lot of people were expecting the market to finally give up some of the gains it made in its rally, given the widening of credit spreads…. Oil and just about every commodity you can think of has broken down again, if not to new lows to pretty close to lows. That has a relation to what's going on in high yield because a lot of those companies are commodity producers or suppliers to commodities producers," said David Bianco, chief U.S. equity strategist at Deutsche Bank.

Retail will also continue to be a focus in the coming week with earnings from Wal-Mart (WMT), Target (TGT), Home Depot (HD) and Best Buy (BBY). Disappointing earnings and forecasts dented stocks in the past week of Macy's (NYSE:M), Nordstrom (JWN) and others.

"It's been a disappointing earnings season, especially with the retailers sounding a sour note at the end of the quarter," said Bianco. "The uplift on nonauto consumer spending on consumer goods has been weak. I think we're looking at the most competition among retailers outside a recession that we've ever seen. A lot of it is for structural reasons, whether they're competing with the Internet, and you now have several large retailers that have everyday low prices now."

Weak earnings, high valuations, declining commodities prices, slower Chinese growth and now worry about the consumer, rose to the surface as traders continue to adjust to the idea that the Fed could be about to raise rates at its Dec. 16 meeting.

"There's a lot of room for the market to move up and down over the next few weeks," said Daniel Suzuki, Band of America Merrill Lynch equity strategist. "Our base case was to take a more cautious view. We know the uncertainty overhang is still going to be there, and the reality that you're unlikely to get hard macrodata point to improving growth until December, when we get November data. We know September was weak, and we got the data that confirmed that. October looks to be flattish."

The S&P 500 had recovered about 10 percent from its summer sell-off, and the forward price to earnings ratio was once again above 17 at the start of the past week. "I think it's a little bit of everything," Suzuki said of the sell-off. "If you think back to where we were in August, the markets were essentially pricing in a collapse in global growth, and when you didn't get the collapse the market has to price it out. And I think that was the biggest driver of the recovery in the markets, but we've been surprised at how strong and fast the recovery has been given the lack of hard data…. Most of this rally has been a result of sentiment and central bank rhetoric as opposed to any meaningful change in the fundamental data."

Suzuki said the drop in oil hurt sentiment, and some strategists say stocks are more sensitive to oil prices when they fall below $45 per barrel. "I think people had gotten a bit more optimistic for the outlook for oil," he said, adding the outlook for oil companies also improved with oil in the upper $40s. "Because they've been able to dramatically reduce their costs, there was increased confidence that some companies were going to be able to survive. And some were going to be able to be profitable with oil prices where they were. But now as we get to $40 and people think it could fall into the $30s, that thesis gets less viable."

Zane Brown, fixed-income strategist at Lord Abbett, said the bond market will be watching anything to do with Fed policy in the coming week, so minutes of the last meeting will be important on Wednesday, as will the Consumer Price Index inflation data.

Brown said investors have become concerned about the widening of high-yield spreads. As of Friday afternoon, the J.P. Morgan High-Yield Index was 15 basis points wider on the day at 678, up from 635 the week earlier, said Brown. The long-term relationship is usually about 590, he said.

"There really does seem to be an underlying concern that we are close to the end of the credit cycle … a lot of that is misplaced, and it's misplaced because they're looking at the impact of oil and what it's doing to companies," he said. "There are increased defaults there. I think that is being applied to the entire credit spectrum, particularly the below-investment-grade spectrum."

But Brown said the credit situation is not really similar to the end of other cycles. "The leverage isn't the same, the earnings relative to interest-rate levels is better," he said, adding investors are also more selective. Another difference is that the quality of issues coming to market is better.

In terms of new, high-yield corporate issuance so far this year, Brown said 55 percent were rated BB and higher, while 45 percent was at the lower end of the credit scale, at B or lower. That is far different than other cycles when the lower-quality issues made up as much as 75 percent of the new issuance, he said.


8:30 a.m.: Empire State Survey


Earnings: Wal-Mart (WMT), Home Depot (HD), TJX (TJX), Dick's Sporting Goods (DKS), JA Solar Holdings (JASO), Jack in the Box (JACK), La-Z-Boy (LZB)

8:30 a.m.: CPI

9:15 a.m.: Industrial production

10 a.m.: NAHB survey

12:35 p.m.: Fed Gov. Jerome Powell at Clearing House conference

3:30 p.m.: Fed Gov. Daniel Tarullo on the financial system

4 p.m.: TIC data

4:10 p.m.: Former Fed Chairman Ben Bernanke on panel at Brookings


Earnings: Target (TGT), Lowe's (LOW), Staples (SPLS), Salesforce.com (CRM), L Brands (LB), Keurig Green Mountain (GMCR), Fresh Market (TFM), Children's Place (PLCE)

8 a.m.: New York Fed's William Dudley, Cleveland Fed's Loretta Mester, Atlanta Fed's Dennis Lockhart on panel at Clearing House Conference

8:30 a.m.: Housing starts

Noon: Dallas Fed President Rob Kaplan on economy and policy

Noon: Bernanke at Economic Club of New York luncheon

2 p.m.: FOMC Minutes


Earnings: Gap (GPS), Best Buy (BBY), Buckle (BKE), Williams Sonoma (WSM), Autodesk (ADSK), JM Smucker (SJM), Intuit (INTU), Ross Stores (ROST), Mentor Graphics (MENT)

8:30 a.m.: Initial claims

10 a.m.: Philadelphia Fed survey

12:30 p.m.: Atlanta Fed's Lockhart at Dekalb Chamber of Commerce

4:45 p.m.: Fed Vice Chairman Stanley Fischer on emerging Asia


Earnings: Abercrombie and Fitch (ANF), Foot Locker (FL)

9 a.m.: St. Louis Fed President James Bullard on economy and monetary policy


1 p.m.: San Francisco Fed President John Williams on monetary policy.

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