Poll results: How deep is the rabbit hole?

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I posted an opinion poll about the outlook for the US stock market a few days ago. In essence, the poll set out to determine readers’ views about the direction of the stock market over the next few months. More specifically the poll asked whether the Dow Jones Industrial Average would be up or down from its level on October 16 (8,578) by the end of October 2008 and December 2008 respectively.

A total of 473 people participated in the October poll and 441 in the December poll, answering as follows:


Most of the readers see the market below 8,578 by the end of October (i.e. 5.0% down from the current level), whereas the vote was about equal between bulls and bears for the period through year end.

Interestingly, since the Dow’s climatic low of 7,896 on October 10, 2008, the market has recovered by 14.4% – not all that far away from the “official” bull market definition of a 20% increase!

Signs of improvement in the credit markets have certainly helped the rally along. The so-called Ted spread (the three-month dollar Libor rate minus the three-month Treasury Bill rate) has narrowed by 180 basis points to 2.77% since Black Friday, October 10. (The five-year pre-credit crisis average was 34 basis points.)


Source: Plexus Asset Management (based on data from I-Net Bridge)

Some further good news came from the sharp narrowing in credit default swap (CDS) spreads of the major US counterparties. The graph below, courtesy of Scott Grannis (Calafia Beach Pundit), shows the strong relationship between CDS spreads and stock prices.


Are swaps forecasting a further improvement in stock markets? I believe equities have the potential for a further advance through year end, especially if credit spreads normalize further and the lows of October 10 hold. Although we are possibly in the early stages of a broad phase of base development, my concern remains the outlook for earnings. If estimates turn out to be overly optimistic, a secular low may not necessarily have been reached.

Friend Paul Kedrosky (Infectious Greed) summarized the situation as follows: “After all, it’s only a credit crisis plus a horrible recession, so get rid of the credit crisis and all you’ve got is the worst recession in decades. That has to be a recipe for a relief rally, even if I remain convinced that we end up churning away for months as the market tries to figure out how bad this downturn is likely to be.”

This is where the ultimate driver of stock prices, earnings, enters the equation.

Related articles:
Poll du Jour: How deep is the rabbit hole?


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4 comments to Poll results: How deep is the rabbit hole?

  • Tommy

    I was surprised by the results of your polls, I guessed there would be much greater bearish sentiment.
    One point on which I differ with you is the ultimate driver of stock prices, I think confidence is the ultimate driver of stock prices, not earnings. Witness the trend of P/E ratios, they have been at historically higher levels during every subsequent bull market at least since the Great Depression.
    I think that confidence has been shaken in the USA so I guess that future bull markets will not reach such astronomical heights in terms of P/E.
    That´s what my crystal ball tells me, and I will invest accordingly.

    Keep up the good work.

  • Eugene

    Nice article. Thanks. 🙂 Eugene

  • Tommy: I have prepared a chart of the S&P 500 price index compared with the S&P 500 earnings index, going back to 1958. The two series move in line, although short-term deviations occur from time to time as a result of aspects such as sentiment, interest rates, etc.

    The link is: http://download.easy-web.co.za/22102008.gif

  • Tommy


    Thanks for the link, there certainly is no substitute for facts!

    My read of the chart is as follows:

    ´58-´72 growth of prices and earnings roughly in-line
    ´73-´90 earnings grew faster, therefore P/E declined
    ´91-´07 prices grew faster, P/E increased

    I suspect we´re moving back to a ´73-´90 scenario, a lot of investors have been burned and will be more cautious, the home ATM will no longer finance growth, and credit criteria will be more stringent. All of that spells much slower growth for the G-20 economies. Even so, the breadth of the US economy will reaffirm its leadership.

    Stay tuned to “Postcards from the Cape” to find out what happens!


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