Stock Market Battles Between Technical's and Fundamentals

By: Nadeem_Walayat

Stocks bounced from extreme oversold levels just over a week ago, the imminent low was called for the Dow index on the 14th July, which laid a rough road map for a stocks rally into September 2008. However technical's are at the mercy of two key fundamentals and those are corporate earnings and the deepening credit crisis.

The fact of the matter is that financial analysts in the City and Wall Street have a vested interest in giving a positive spin on earnings of the companies that they cover, for the name of the game is in picking stocks that will out perform that of other analysts therefore there exists a tendency to favour on the side of optimism. However virtually all financial analysts are guilty of this which has led to unrealistic earnings expectations for the market as whole of earnings growth rates of 20% for 2008 at the start of this year. This was totally unrealistic in the face of a slowing economy and deepening crisis in the banking sector as has been written about on a near weekly basis at the Market Oracle.

As actual earnings are announced, analysts are forced to reign in their fantasy land valuations which results in sharp drops in stock prices as if hit by shots out of the blue, much as transpired during the last stocks bear market where the earnings were only cut after stocks had been pummeled into the ground. as neither the CEO's nor analysts admit being wrong unless forced into an about face which usually hits the whole market across the board.

A recession will mean a fall in corporate earnings of as much as 30%, whilst at the moment analysts are still forecasting earnings growth for this year and next year combined of as much as 20%. Therefore this suggests there is the potential for further serious markdowns in stock prices either in advance of or following further bad earnings reports. All this suggests the stocks bear market looks to have much further to run as Price / Earnings ratios will expand in the face of falling earnings, and therefore pull stock prices lower.

The credit crisis has so far claimed a handful of banks with a further handful teetering on the brink. False optimism reigns that the number of failures will be limited to a dozen or so,but as we saw with the 1990's Savings and Loans crisis, the number of failures kept exploding ever higher until more than 1000 banks and financial's went bust. Today's crisis is in many ways far worse and global in nature, and could in the final analysis claim far more than 1000 banks. Therefore we are still in the early stages of the credit crisis which has deeply bearish overtones for the banking sector and wider economy in terms of availability of credit both for consumers and the corporate sector.

In the meantime technical's and seasonal factors such as the influence of the US presidential cycle suggest giving stocks a technical uplift into the end of the this year, barring strong corrections along the way in September and in November. For instance the UK's FTSE 100 index on the basis of seasonal technical factors should see a rally back towards 6000 by the end of this year, a move of as much as 13% as the FTSE is giving indications of being in a wide trading range of between 6300 and 5000 that looks set to last for several years.

However technical's are at the mercy of deteriorating fundamentals, the key here is to look for technical triggers generated by fundamental events such as breaks to new lows, and the behaviour of market volatility as measured by the VIX, as to pointers to which will have the eventual upper hand and as to what the stock market sees beyond the current phase of the credit crisis during 2009.

See this weeks newsletter (always FREE) for a number of possible scenarios for the stock market trend in the face of deteriorating fundamentals.

By Nadeem Walayat
http://www.marketoracle.co.uk

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Nadeem Walayat has over 20 years experience of trading, analysing and forecasting the financial markets, including one of few who both anticipated and Beat the 1987 Crash. Nadeem is the Editor of The Market Oracle, a FREE Daily Financial Markets Analysis & Forecasting online publication. We present in-depth analysis from over 150 experienced analysts on a range of views of the probable direction of the financial markets. Thus enabling our readers to arrive at an informed opinion on future market direction. http://www.marketoracle.co.uk

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