Stocks & Investing - Wednesday Look Ahead: Rally Turns Two as Europe Sovereign Woes and Oil Combine to Test It - CNBC

Wall Street's bull enters its third year with a furrowed brow.

Tensions in the Middle East, and the resulting run up in oil prices, combined with seemingly unending worries around Europe's weakest sovereigns are powerful hurdles facing the young bull. But many analysts and traders think those problems are temporary, and the market can continue to climb on stronger economic news and earnings gains.

However, they are also watching the next series of obstacles, including how elected officials tackle the growing federal budget deficit. There is also the Fed's ultimate unwind of its easy money policies that have helped juice the stock market's gains. The Fed is due to end its quantitative easing program in June, and the risk then will be how stocks react in a rising rate environment.

The Dow Tuesday rose 124 points, or 1 percent to 12,214, while the S&P 500 was up 0.9 percent at 1321. The Nasdaq was 0.7 percent higher at 2765. Stocks were lifted along with bank shares, which surged about 2.8 percent after Bank of America said it hoped to raise its dividend and carry out share buybacks.

Tech stocks were late day movers and could weigh on Wednesday's market. Fiber optic component maker Finisar tumbled more than 30 percent after it issued a disappointing forecast and said China demand was slowing. That comment smacked other companies in the space, including high-flier JDS Uniphase, which lost 13 percent after the bell. Texas Instruments, in a less spectacular move, also lost ground in late trading afterit narrowed its guidance and said that demand for chips for televisions remains weak.

Baby Bull

Stocks two years ago Wednesday troughed as fear pervaded the markets and economy. The S&P 500 closed at 676 that day, well off its 2007 high of 1565, and blue chips traded at fractions of their current value. Since then the S&P has nearly doubled.

"I think it is interesting that on the two year anniversary, we've still got something on the list to perpetually worry about, and why you should be bearish," said James Paulsen, chief investment strategist at Wells Capital Management.

Oil is one of those worries. Bubbling crude prices have weighed on the stock market since rebellion erupted in Libya last month.Oil prices slipped slightly, falling below $105 per barrel as talk that OPEC would ramp up production to make up for Libya soothed markets. Meanwhile, the fighting in Libya continued and Muamaar Gaddafi's forces seemed to gain ground against the rebels.

"This is eluding me," said veteran trader Art Cashin of the stock market's rally Tuesday. "If they're not rioting in the streets, we go up, and if oil rallies, we go down."

Cashin, director of floor operations for UBS, said the two year anniversary of the market's bottoming is not particularly important as a milestone. "It's kind of like a 37th wedding anniversary. It's pleasant to remember, but doesn't have a great deal of impact."

Paulsen said the negativity from oil prices and Europe's woes will probably prove a positive for stocks, which had moved higher in an unchecked fashion for weeks. "I think if anything, I'm moving the other way. Here's what we've done. We've caused a little pause in this...We've marked some time and while we've bought some time, the fundamentals moved up again," he said.

Yet oil is a concern and the Middle East is an uncertainty. "We don't have a shortage of energy. What we've created is the fear of a shortage of energy," he said. Paulsen points out that rise in oil has paralleled a decline in some other commodities, like grains and copper, and that could help alleviate some inflation fears if oil doesn't continue to shoot higher.

Euro Zoned

The dollar reversed course Tuesday, moving higher against the euro and other currencies. The euro's weakness was particularly interesting, and it fell more than a half a percent to 1.3899 form above 1.40 earlier in the week.

"It's caught in a tug of war between interest rate expectations and the fear that the sovereign debt issues are coming back. It's hard to say butt we may be getting back to the days when we're trading off of issuance," said Boris Schlossberg of GFT Forex. The euro has been rising on interest rate expectations, particularly after ECB President Jean-Claude Trichet said a rate rise is possible but not certain in April.

Friday marks an important day for the euro zone as leaders meet for a summit where they are expected to agree to a "competitiveness pact," which Germany and France have pushed. The pact is seen as a minor step, and analysts have criticized it for failing to address such issues as debt restructuring.

What to Watch

There is not much economic news expected Wednesday. Wholesale trade for January is released at 10 a.m.

The Treasury auctions $21 billion in reopened 10 year notes at 1 p.m. Bond yields rose Tuesday, with the 10-year rising to 3.55 percent. Except for February, "this might prove one of the highest yield offerings since April or May of last year," said Ian Lyngen, senior Treasury strategist at CRT Capital. The 10-year was yielding 3.665 at February's auction.