2007, 2008 recession, kennyboy??? At National City Corp. in Cleveland, portfolio managers who oversee $34 billion for private investment clients are downright bullish, calling for the Dow Jones Industrial Average to rise 13% to 15000 this year. They see the S&P 500 reaching 1700, up almost 16% on the year. But first, even they expect more market turbulence.
"The debate today is not whether thunder and lightning are coming, but, rather, how severe the storm will be and how long it will last," warned National City's Tim Swanson and Nick Raich in a recent report to clients.
National City sees the storm's passing without doing lasting damage. But in Minneapolis, the folks who oversee $100 billion at First American Funds have a darker view.
"Recession is probably more likely than not in 2008," David Chalupnik and Keith Hembre of First American warned clients as the year ended. They think troubles in the first half of the year will be severe, with corporate profits and major stock indexes falling. While they see a rebound in the second half, they expect it to pull the S&P 500 up only to 1550, a 5.6% increase for the year.
As last year ended, investors again were preoccupied with the consumer and his willingness to spend. Although employment levels and consumer-spending data weren't yet signaling recession, fears spread that it was just a matter of time before high gasoline prices and the deteriorating mortgage and housing markets forced the consumer to cut back on spending.
Because consumer spending accounts for more than two-thirds of the economy, the consumer's resilience has been one of the major reasons for the past few years' surprisingly strong economic growth. The optimists pointed out that, as long as employment levels remain robust, consumers are likely to continue spending, keeping the economy growing and helping to support corporate profits and stock prices.
The worry is that profits for companies in the S&P 500 began a decline during the third quarter of last year, which came as a surprise to most stock analysts. Analysts believe that when fourth-quarter results are announced later this month, they will show that the decline continued and that it was a big reason for investors' unease. The analysts forecast that profits overall should pick back up this year, and stock strength could depend a lot on whether they do. Not everyone is optimistic.
"Going into the new year, we are going to have a bigger problem than we have had so far. The economy is going to slow down. As higher costs trickle through, you are going to see pressure on corporate profits," says Tim Smalls, head of U.S. stock trading at Greenwich, Conn., brokerage firm Execution LLC.
One sign of concern was the late-year softness in Treasury-bond yields -- despite upticks in several inflation readings. Ordinarily, when inflation fears rise, Treasury yields do as well, reflecting expectations that the Federal Reserve will have to increase interest rates to hold inflation in check. That wasn't happening late last year.
The yield of the 10-year Treasury note finished the year at just 4.033%, near its low for 2007. As recently as July, before the credit worries hit, the yield was above 5%. The decline reflected expectations that the Fed would cut interest rates sharply in the coming months to stimulate the economy and prevent recession. Although the Fed did cut its benchmark rate three times starting in September, by a total of a full percentage point to 4.25%, investors have begun to debate whether the Fed has "fallen behind the curve" and is cutting rates too little, too late.
On top of economic and profit concerns, some investors are worried that the bull market is showing signs of age. It has been more than five years since the bull market began in October 2002. During that period, the Dow Jones Industrial Average has been surprisingly resilient, falling as much as 10% from a high -- the traditional definition of a correction -- just once, in November 2007.
Currently, stock indexes are being supported by shares of a diminishing group of large companies, whose ability to sell their products around the globe helped them maintain profits despite the U.S. economic problems. That big-stock strength is why both the Dow industrials and the S&P 500 have been able to show gains for the year, despite recent profit declines for the S&P overall.
An aging bull market supported by a dwindling number of stocks tends to be a recipe for trouble. For investors who haven't concentrated their money in the large stocks that still are holding up, the trouble already has hit.
"It could be another difficult year for small-cap stocks, especially in the first half, in our opinion, as small caps are much more economically sensitive than large, and with the looming economic slowdown, performance could slip," wrote Merrill Lynch small-stock strategist Steven DeSanctis in a report to clients.
Moreover, 2008 is a presidential-election year, and presidential elections can be tricky for stocks. Election uncertainty can put a lid on stock gains until late summer. If the incumbent party seems headed for re-election, keeping change to a minimum, investors may look past the election and bid stocks higher. If markets remain nervous about the election, stock trading can remain volatile well into the fall.
"In 2008, we may see a range-bound market during the lead-up to the election, with a fourth-quarter breakout to the upside as the uncertainty fades and the U.S. economy avoids a recession," bullish market strategist Jeffrey Kleintop of LPL Financial Services in Boston told clients in a report. If the same party wins control of both the White House and Congress and tries to enact sweeping changes, however, that "may raise the level of uncertainty for investors," Mr. Kleintop warned.
Also complicating things is the unclear future of the dollar, which ended the year down 9.6% against the euro. A weak dollar affects foreign interest in U.S. securities, as well as the ability of American companies to sell abroad. The late-year inflation uptick in 2007 also could be a problem, if it makes it harder for the Fed to keep cutting rates.
How well the stock market weathers all of this will depend heavily on how successful Fed rate cuts are at keeping the U.S. economy growing -- and on whether economic growth remains robust in countries such as China and India. Unlike the bull market of the late 1990s, which was driven by U.S. growth and innovation, this bull market lately has been fueled by strong economies outside the U.S., and its future depends heavily on the continued strength of those economies.
"We expect 2008 to be as 'interesting' as 2007 has proven to be," Messrs. Raich and Swanson of National City wrote in their year-end report to clients. |
