Outlook For 2008: Big On Turmoil, Small On Gains

Source : The Business Times, January 7, 2008

WALL STREET INSIGHT

Most economists expect US economy to narrowly avoid recession this year

NO MATTER whether stocks in the US equity market are able to thrive this year or even achieve the slim single-digit gains that most of the Wall Street market strategists The Business Times polled have set for their end of year targets, this year will be amongst the most challenging market environments facing Wall Street in many years.

'2008 will certainly not be a year short of major storm clouds,' said Jim Awad, chairman of WP Stewart, who is forecasting gains of 4 to 6 per cent for blue chip stocks and the broader S&P 500. 'It will be a volatile and difficult year, with the positive pull of export demand from higher growth overseas battling the drag of a domestic slowdown and financial sector troubles.'

The US market's start to the year reflected the daunting challenge, as the Dow Jones Industrial Average closed 2008's first day of trading with a 220.86-point loss, or 1.67 per cent to 13,043.96, the worst point decline for the Dow at the start of any trading year.

'That's not the way you want to start off a new year, it's certainly bearish as omens go,' said Ryan & Beck senior market strategist Joseph Battipaglia. 'But still, it's only the first day of the year.'

Indeed, and with hundreds more trading sessions to go in 2008, Wall Street analysts expect the good to outweigh the bad this year, if only by the slimmest of margins.

First, the good news. Most stock market strategists expect the US equities markets to move up during the 12 months, registering modest gains. Large capitalisation, multinational companies, especially makers of information technology equipment and software, should lead the way. The US economy should narrowly avoid a recession, beginning to show signs of recovery by the end of the year, most Wall Street economists say.

Economists like Merrill Lynch's David Rosenberg believe the US Federal Reserve will be active in cutting short term interest rates this year, bringing solace to investors focused on the economic slowdown. Mr Rosenberg thinks that data like Wednesday's weak manufacturing report could push the rate-setting committee to order a cut of fifty basis points at its January meeting. 'The voting members are becoming more sanguine about inflation and more concerned about tightening credit conditions and deterioration in the financial market, as noted in the minutes of their last meeting,' he said.

The bad news: That's the best-case scenario for what is expected to be a tumultuous 2008 for stock investors.

Despite the US housing market's year-long collapse in 2007 and over US$40 billion in write-offs by banks looking to clear their books of sub-prime loans and investments, the coming year presents the threat of more of the same. A severely wounded housing market, coupled with loan-wary credit markets, could act together to pull the US economy into a prolonged recession, with several quarters of falling profits for US corporations in the wider economy, not just financial businesses.

'We certainly shouldn't expect to be rescued by corporate profits this year,' said Charles Crane, investment strategist at Scotsman Capital. 'But companies could also end up faring more solidly than many investors seem to be expecting, and that could provide a boost mid-year,' he said.

FedEx, a leading indicator for the US economy, is a good example. The logistics company was one of the first to top out in 1999 and one of the first to bottom out in 2000.

In its last quarterly report FedEx offered downward guidance for the current quarter, which ends next month. But it sounded a more confident note for its first quarter of 2008, which ends in May, indicating it sees a pick-up in business as early as the spring.

Mr Battipaglia believes that, short of an outright melt-down and panic, 'all of the bad stuff is out there already. It could get worse, but it's already very high and printed in bold on investors' radar screens,' positioning stocks for a solid bounce-back later in the year.

Although the increased chance of recession, inflation and even stagflation cannot be dismissed, said Citigroup chief investment strategist Tobias Levkovich, 'should recession be averted, as we currently expect, some of the most beaten-up groups like diversified financials and retailers would most likely act as coiled springs and lead markets higher this year.'

He claimed that market fundamentals 'still argue for double-digit stock price appreciation after a disappointing 2007. Valuation, implied earnings expectations and select sentiment approaches all support respectable upside potential.' He set year-end market targets at 1,675 for the S&P 500 and 15,100 for the Dow.

Mr Crane is not as bullish as Mr. Levkovich, forecasting single digit gains for the major indexes, but he agrees that many stocks are venturing into oversold territory. 'There will be plenty of opportunities to make better returns in individual stocks,' he said.