Wednesday, February 06, 2008

Poll results so far

I've placed three questions on the right panel of this blog, and although the number of respondents so far is small, (7, 9 and 16) I'd like to highlight the trends now before the market dips into the next phase of the crash.
  • Out of 16 responders, 11 believe that the Dow will bottom out above 9000, which is above my predicted low of 8500. Two answerers think the Dow will drop below 7000.
  • Only six visitors were willing to divulge what types of investments they were in, and all of them indicated they were at least partially invested in stocks or regular mutual funds. I predict that many of these holdouts will be bailing in the next month or two as part of the crash down to Dow 8500.
  • Nine people ventured a guess as to what the next bubble will be, and four of them agreed it would be emerging market stocks. I take this to be a contrarian indicator, since people tend to avoid investments that scare them, and anything that investors avoid will have a hard time inflating into an overvalued bubble.
The "Dow" and "investments" questions will expire in a couple of weeks, since I'm sure the answers will be very different at the end of a crash. On the other hand, the next investment bubble may take years to materialize, so that question will remain up for all of 2008.


Anonymous said...

What was the Fed response during the 678 crashes you highlighted? It seems the recent 125 basis point cut and potential additional 50 point cut (March Fed meeting) would have some medium term (Q3-4 2008) positive effect on economic growth and therefore equities. I am in a larger cash position than I have been in a number of years but an additional ~35% drop in the S&P seem like a lot given the 15% drop off the high. 50% drop from the high? I'm skeptical. Another 15% (S&P 11000)wouldn't surprise me.

Jody said...

I think low interest rates (or interest rate cuts) can only do so much to guide the market, and there is evidence that previous crashes/bear markets were indeed accompanied by interest rate cuts that didn't prevent the declines. Here's a graph of the prime lending rate, and here's a graph of the federal funds rate.

Interest rates were already pretty low in the late 1950's, but there was a bear market in 1956-7 anyways. Interest rates were cut in mid-1966, but a crash happened that year anyways. Rates were cut massively between 1974 and 1975, but a 2-year bear market started in 1976 anyways. Etc...

My understanding of interest rate cuts is that they spur economic growth by making it easier for businesses to borrow money, and that they make stocks a more attractive investment than bonds due to lower bond yields. However, there are three problems today that nullify these effects:

(1) We already seem to be heading into a recession, so these cuts may be too little too late.

(2) Thanks to the sub-prime loan debacle and billions in potential lost payments, banks are much less willing to lend money today - regardless of interest rates. If banks aren't lending money, then business can't borrow money to grow with.

(3) Stocks are more worthless now in terms of dividend yield than they've been in the history of the stock market. The S&P 500 today pays less than a 2% dividend yield, while the historical range since the 1920's has been between 3% and 6%. In order to make stocks more attractive than bonds, we would have to lower interest rates to almost zero, and that isn't going to happen.