The Case for a Market Bounce

The price action in the equity markets today was nothing short of impressive. We literally had a W shaped trading day where stocks opened down 600 points, rallied back into positive territory, sold off again by another 600 points before recovering most of its losses by the end day. The volatility that we have seen in the currency market is only an extension of the movements in equities. On an intraday basis, the Dow saw a 1000 point swing, with stocks up as much as 300 points in the last hour of trading. Two very different factors drove the sharp reversal – no one wanted to be short carry trades going into the G7 meeting and the money from the Lehman credit default swaps are coming back into the markets.

DJ Chart - Oct. 10 2008

The Case for a Bounce Next Week

Even though the economy could still be in for more trouble over the coming months, there is a case for a major bounce next week. Many people are arguing that this week’s sell-off in stocks is tied to the need to raise cash to settle the Lehman Brothers’ credit default swaps. For those who bought protection against a bankruptcy on Lehman brothers, they are set to get 91.375 cents on the dollar. The sellers of the protection will now have to make cash payments of more than $270 billion to the buyers. As the money changes hands, those who have bought protection could now put their payments to work in the equity markets which could pave the way for a serious bounce.

A Look at P/E Ratios: Are Stocks Becoming Good Values?

The Dow Jones Industrial Average has fallen more than 40 percent over the past year, leaving many investors wondering whether stocks have finally become cheap. Price to Earnings or P/E ratios has fallen to the lowest level in 23 years. With the S&P 500 trading at 860, the estimated P/E ratio according to the NY Times was just below 12. Over the past century, the average P/E ratio was approximately 15.5.

According to a study by Yale Economics Professor Robert Shiller, the P/E ratios in the UK and Germany have fallen to levels that have only been seen 4 or 5 times in 150 years. From that perspective, P/E levels have fallen significantly but it is important to remember that earnings are expected to decline and P/E ratios always fall below the average in recessions. If economic conditions are as bad as the stagflationary period of the 1970s, then P/E levels could still fall to single digits. USD/JPY is due for a bounce, but in the long run, the prospect of further rate cuts from the US should continue to drive the currency pair lower.

In addition to the G7 meeting, we are expecting US producer prices, consumer prices, retail sales, manufacturing and housing market reports next week.

Photo: MarketWatch

About Kathy Lien 235 Articles

Kathy Lien is an Internationally Published Author and Chief Strategist of, one of the world’s most popular online websites for currency research. Her trading books include the highly acclaimed, Day Trading the Currency Market: Technical and Fundamental Strategies to Profit form Market Swings (2005, Wiley); High Probability Trading Setups for the Currency Market E-Book (2006, Investopedia); and Millionaire Traders: How Everyday People Are Beating Wall Street at Its Own Game (2007, Wiley). As Chief Currency Strategist at FXCM, Kathy is responsible for providing research and analysis for DailyFX, the research arm of FXCM. She also co-edits the BK Forex Advisor, an Premium Service with Boris Schlossberg – one of the few investment advisory letters focusing strictly on the 2 Trillion/day FX market.

Kathy is also one of the authors of Investopedia’s Forex Education section and has written for, the Asia Times Online, Stocks & Commodities Magazine, MarketWatch, ActiveTrader Magazine, Currency Trader, Futures Magazine and SFO. She is frequently quoted by Bloomberg, Reuters, the Wall street Journal, and the International Herald Tribune and has appeared on CNN, CNBC, CBS and Bloomberg Radio. She has also hosted trader chats on EliteTrader, eSignal and FXStreet, sharing her expertise in both technical and fundamental analysis.

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