A wild ride into uncertainty

By Tom Petruno

Jan. 1, 2008 12 AM PT

Times Staff Writer

The world’s investors rethought the concept of risk in 2007, and the result was a vast divergence in performance among financial markets.

Suddenly, to some people Indian stocks looked safer than the U.S. housing market, long considered a pillar of security.

Speculators shied away from American junk bonds and small-company stocks but remained ravenous for commodities such as wheat, gold and cotton.

On Wall Street, as the sub-prime mortgage debacle fueled deep concerns about the long-term effects on the U.S. economy and banking system, many investors showed a new respect for blue-chip companies that appeared financially strong enough to weather whatever lay ahead.

Microsoft Corp. shares surged 19% for the year, their best calendar-year performance since 2001. Coca-Cola Co. shares jumped 27%, their best advance since 1996.

The best-known U.S. blue-chip stock indexes, however, managed only middling gains in 2007. They were weighed down by the steep losses suffered by housing- and financial-related issues.

The Dow Jones industrial average, which dipped 101.05 points, or 0.8%, to 13,264.82 on Monday, was up 801.67 points, or 6.4%, for the year.

Including dividends, the Dow’s “total return” was 8.9% -- short of the double-digit gain that many Wall Street pros had expected a year ago.

The Standard & Poor’s 500 index had a 3.5% price gain and was up 5.5% with dividends. That wasn’t much better than what investors could have earned in a money market mutual fund.

Of course, some buy-and-hold stock investors may be glad just to have come through the year with a positive return, given what took place in the housing market and banking system.

Wall Street suffered sharp pullbacks in August and again in the fourth quarter as the housing mess worsened, losses ballooned on mortgage-backed securities, and banks and brokerages became reluctant to lend to one another.

Stocks rebounded after the Federal Reserve on Sept. 18 began to cut short-term interest rates to bolster the financial system. But the rally soon faded.

From its record high of 14,164.53 on Oct. 9 the Dow plunged to 12,743.44 on Nov. 26. That 10% decline was the index’s worst slump in more than four years.

The market has rebounded again in recent weeks, but key indexes still were down sharply in the fourth quarter. The Dow lost 4.5% in the three months; the S&P; 500 slid 3.8%.

Among the few market sectors rising in the fourth quarter: utility stocks. The Dow utility index rose 6.2% in the three months and 16.6% for the year. Utilities are a classic “defensive” play because they are expected to be profitable even if the economy heads south.

Investors also have continued to seek haven in U.S. Treasury securities. The 10-year T-note yield ended Monday at 4.03%, down from 4.7% a year ago. As bond prices rise the yields on the securities fall.

Now, what? Some analysts say battered investors are so poised for disappointment in 2008 that the stock market is more likely to rally than fall further.

“Even a recession really wouldn’t surprise people here,” said Paul Hickey, a principal at investment research firm Bespoke Investment Group in Harrison, N.Y.

He thinks stocks are relatively cheap. The S&P; 500 index, at 1,468.36 on Monday, trades at about 14 times estimated 2008 earnings per share, according to data tracker Thomson Financial.

But many big investors remain cautious, fearful that the housing market crash and tight credit will drag down the U.S. economy, corporate earnings and global investors’ perceptions of the prospects for American stocks.

“We want to be pretty defensive in the first half of the year,” said Jack Ablin, who oversees $55 billion as chief investment officer at Harris Private Bank in Chicago. “I think there are better bargains ahead.”

Here’s a closer look at the performance of U.S. and foreign stocks in 2007:

* U.S. stocks: Surging market volatility and rising worries about the economy put an end to the performance edge that small-company stocks have held over big-name shares for most of this decade.

Two closely watched small-stock indexes lost ground in 2007. The Russell 2,000 was down 2.7% and a Standard & Poor’s index of 600 small companies dipped 1.2% -- their first calendar-year losses since 2002.

Investors moved away from smaller stocks and toward bigger names in part because larger companies can provide a refuge amid uncertainty, analysts said.

But another factor also spurred the shift: If the U.S. economy continues to slow, multinational companies provide a way to cash in on growth overseas. And the dollar’s decline against other major currencies in 2007 has helped make U.S. exports less expensive for foreign consumers.

The hunt for growth investments also drew investors to the technology sector. The Nasdaq composite index, which is dominated by big tech companies, lost 22.18 points, or 0.8%, to 2,652.28 on Monday, but was up 9.8% for the year -- its best gain for any year since it rocketed 50% in 2003, the first full year of the current bull market.

Many money managers remain bullish on big stocks and on tech issues. A survey last month of nearly 300 investment managers by Russell Investments of Tacoma, Wash., showed 78% were optimistic about tech, a record high for the survey, which is conducted quarterly.

* Foreign stocks. Overseas markets generally trounced the U.S. stock market in 2007, continuing the trend of the last few years.

The bet: There’s enough momentum in booming foreign economies -- particularly emerging markets -- to keep those stocks moving up, despite America’s troubles. In a major turnabout, historically, some investors now see emerging markets as less risky than the U.S. market.

A Merrill Lynch & Co. survey of global fund managers in November showed that most “continued to stand by an investment strategy centered on the idea that the rest of the world can decouple from the U.S. sub-prime crisis,” Merrill said.

Most Asian markets were global stars in 2007 as China’s economy continued to zoom. The Shanghai composite stock index surged 97% for the year. The Sensex index in India jumped 47% and South Korea’s main index rallied 32%.

Japan was odd man out, as its economy remained sluggish. The Nikkei-225 stock index fell 11.1% for the year.

Stocks performed better in Europe than in Japan, but the global credit crunch took a toll on European investors’ confidence. The French market was up just 1.3% for the year in euros; the Swiss market dipped 3.4% in francs.

For U.S. investors, however, the weak dollar boosted stock returns in Europe and elsewhere. The French market was up 12.1% for the year in dollars. The Swiss market gained 4% in dollars.

Bullishness about foreign economic growth, especially in emerging markets, also has driven the rally in prices of many commodities over the last few years. Crude oil ended Monday at $95.98 a barrel, down 2 cents for the day but up $34.93, or 57%, for the year.

But with expectations high for foreign stocks and their economies, a growth slowdown overseas in 2008 would leave foreign markets vulnerable to a sell-off, analysts warn.

“It’s crazy to assume that emerging markets won’t be affected by a U.S. slowdown,” said Byron Wien, chief investment strategist at Pequot Ventures in Westport, Conn.

“But they won’t be destroyed,” he said, and on balance, “I think foreign will do better than the U.S.” in 2008.

tom.petruno@latimes.com

(BEGIN TEXT OF INFOBOX)

WHAT WAS HOT

BIG-NAME U.S. STOCKS

Why: Safer harbors in a stormy market

What: McDonald’s, +33%; Microsoft, +19%

EMERGING-MARKET STOCKS

Why: Zooming economies, rising wealth

What: India, +47%; Brazil, +44%

COMMODITIES

Why: Strong global demand