Investors’ 4 major concerns for 2008
Investors typically face a new year with a mix of hope and apprehension.
This time around the backdrop favors a heavy dose of apprehension.
The economy, corporate earnings, the financial system and the presidential election all are huge question marks for 2008. You want certainty? That was last year -- or so many people thought.
Flash back to a year ago. Remember the global capital glut? Hard to believe, but the biggest “problem” Wall Street thought it faced as 2007 dawned was too much money chasing too few investment opportunities. Euphoria was boundless.
From that to a housing market crash and a fearsome credit crunch in less than 12 months.
Yet if stock investors are nervous, they haven’t bailed out in droves. Hope hasn’t vanished.
The average U.S. stock mutual fund is up 6.7% for the year, according to Morningstar Inc. The average foreign stock fund is up 16.3%. But note that those gains have been supported by strength in big-name stocks while many smaller stocks have fallen since midyear.
As the new year begins, here are four concerns that will dominate as investors look for clues to markets’ next big move:
The economy. “Recession coming,” brokerage Morgan Stanley warned clients in a recent report. “Recession averted,” countered a report from Deutsche Bank Alex. Brown.
Of course, opinions on the economic outlook are rarely uniform. But this time the views are extraordinarily divergent.
One camp sees the effects of the housing crash filtering through the economy and turning the 6-year-old expansion into recession, or at best no growth.
Morgan Stanley economists said three factors would tip the balance toward recession: “Financial conditions are tighter, [economic] weakness is broadening into capital spending and global growth is slowing.”
Another camp believes the U.S. will avoid recession thanks in large part to the classic remedy: lower interest rates engineered by the Federal Reserve, which has reduced its benchmark short-term rate three times since mid-September.
Further cuts by the Fed “will likely lead to acceleration in growth during the second half of 2008,” said Larry Adam, investment strategist at Deutsche Bank Alex. Brown in Baltimore.
What if the recession camp has it right? The expectation would be that investors would flee many stocks in 2008 because companies’ fortunes generally are tied to the economy’s.
Many analysts say they’ll take their cue on the growth outlook from the government’s monthly employment reports. The economy has continued to create jobs despite the housing mess. If employment turns negative, however, so will the outlook for consumers’ income and spending, greasing the skids for recession.
Some stock market pros say another factor may be just as important: economic growth abroad. Thanks to booming demand for U.S. exports, “the rest of the world has been keeping us out of recession,” said Brian Stine, investment strategist at Allegiant Asset Management in Cleveland.
He said he was keeping a close watch on China’s economy because it had continued to be a locomotive for the rest of the planet even as U.S. growth had ebbed. “My concern would be if we started to see China slow down significantly,” Stine said.
Corporate earnings. Stock prices are underpinned by investors’ expectations for earnings growth. From the second half of 2003 through 2006, the overall operating earnings of the Standard & Poor’s 500 companies rose at a double-digit pace every quarter -- which in turn kept share prices advancing.
That growth eased to a single-digit pace in the first half of this year. And in the third quarter, S&P; 500 earnings fell 4.5% year over year, the first drop since 2002, according to data firm Thomson Financial.
In the fourth quarter the decline is expected to steepen: Thomson is predicting a 9.4% year-over-year drop, based on analysts’ estimates for the individual S&P; 500 companies.
But the main driver of lower earnings for the S&P; 500 is one industry sector, financial services, as banks and brokerages reel from losses on mortgage securities. By contrast, eight of the index’s 10 major sectors are expected to show earnings gains this quarter.
And analysts remain upbeat about the first quarter of the new year. The S&P; 500 companies overall are expected to post a 5.7% profit gain in the period.
The bad news, however, is that first-quarter earnings growth estimates have fallen for eight of the 10 S&P; sectors since Oct. 1, according to Thomson.
So there’s the risk: If Wall Street still is too optimistic about earnings and analysts continue to cut their 2008 estimates in the next few weeks, it could jolt investors who at the moment believe they can still count on decent profit growth.
The financial system. The ready availability of credit helped power the economic expansion since 2001. It also drove the stock market by abetting a boom in buyouts.
Now, as most everyone knows, many banks and brokerages have become reluctant to lend because of the steep losses they’ve suffered from the mortgage debacle.
If the credit crunch worsens in the first part of 2008 despite the aggressive efforts of the Fed and other central banks to pump money into the system, investors’ fear level is likely to surge. Tighter credit would boost the risk of recession and the risk of more blowups among cash-starved financial firms.
“If people cease to believe in the Fed, then we’ve really got a problem,” said Doug Peta, market strategist at J&W; Seligman & Co. in New York.
The election. For the time being, Wall Street has a lot more to worry about than who wins the presidency in 2008. But the election inevitably will gain in importance for markets.
Many investors may focus on the threat that tax rates on capital gains and dividends could jump if the Democrats take the White House and keep control of Congress.
As the law now stands, the 15% maximum federal tax rates on long-term gains and on dividends will rise after 2010 unless Congress extends them. A number of Democratic presidential candidates are on record favoring higher rates, at least for upper-income investors.
Investors are motivated by much more than taxes, of course. But if the outlooks for the economy, earnings and the financial system don’t improve, the prospect of higher tax rates could become magnified as a threat to markets’ health.
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