The last optimist fights on – for now

Could last week's panic have been a capitulation, when even the most optimistic of optimists threw in the towel and stocks hit bottom?

Everyone was expecting "the Crash of 2008" last Monday, as Gerard Baker noted in The Times. But US equities had their best week since early February, with the S&P 500 gaining over 3% and continuing to climb on Monday.

The Fed's rescue of Bear Stearns staved off a bank failure that "threatened to split Wall Street asunder", says The Economist. Along with the improved JP Morgan offer and the Fed's various attempts to improve liquidity in the financial system, it has fuelled hopes that the worst of the subprime crisis may soon be over.

The 0.75% interest-rate cut and the successful initial public offering (IPO) of credit card group Visa (V) a rare bloom in the barren IPO market also cheered investors. European markets took their cue from Wall Street, bouncing off late-2005 levels on Tuesday.

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Optimists are hoping that last week's events marked a bottom for equities, says John Authers in the FT. They point out that the panic seen early last week is typical of capitulation, when even the last optimists throw in the towel, clearing the way for cheap shares to rebound. UK analysts also reckon a bounce is due. A Sunday Times poll shows that they are forecasting an average 15% rise in the FTSE 100 by the end of the year.

Yet it's hard to share this confidence. The key problem is that "we are still in the early innings of the bursting of the housing and credit bubbles", as hedge fund T2Partners puts it. Central banks can alleviate liquidity problems, but the solvency issue, "the concern that banks may still be sitting on losses that could wipe out their capital, won't go away soon", says Dan Denning on Until the US housing market bottoms out, allowing investors to gauge the level of defaults and resultant losses, "the credit markets will continue to look sick and bankers will also continue to hoard cash", says Jeremy Warner in The Independent.

But housing shows no sign of bottoming out and then there's other losses to consider as America moves into recession, including commercial property, credit card and auto loans. Goldman Sachs estimates that total losses across the global system will hit $1.1trn. The darkening economic outlook provides plenty of scope for earnings disappointments. In the US, "recession-tinged conditions still need to be filtered into earnings estimates", says Michael Santoli in Barron's.

Investors Chronicle notes that European equity analysts are ratcheting down their expectations, with the ratio of upgrades to downgrades showing the largest negative three-month change in Germany, Spain and the UK. Given that global growth is slowing and the UK seems just as vulnerable to a nasty slowdown as the US, due to its exposure to the financial sector and its housing and personal debt bubbles, it's no wonder Ted Scott of F&C warns that the FTSE, on a forecast p/e of 11, may soon be pricier as "earnings are at risk".

Meanwhile, the market's dividend yield has exceeded the yield on five-year gilts, which last occurred in March 2003 and proved a buy signal, as Neil Hume points out in the FT. But while it means stocks are cheap compared to gilts, it could also indicate that the market expects a contraction in UK dividend payments, 37% of which are provided by the financial sector. Morgan Stanley expects bank dividends to fall 5% this year and 15% next year as growth slows.

UK and European stocks need to fall by another 25% and 15% respectively to hit average peak-to-trough falls of previous bear markets, says Citigroup. Now throw in the fact that sentiment is nowhere near as depressed as it is at genuine market bottoms "Are you ready for Dow 20,000?", asked Barron's this week and this hardly looks like a buying opportunity.