Stock experts see divided year ahead
The first half of '08 could spell trouble. The second half is likely to be more profitable.
Ten top investment strategists polled by USA TODAY are predicting that stocks will rise for a sixth consecutive year in '08 - but only after overcoming a challenging and volatile first six months. The full-year performance predictions for the benchmark Standard & Poor's 500 range from a 3.5 percent gain to a more robust return of 14.4 percent. The average return: 9.2 percent.
1ST HALF
2007 is history. But the problems that plagued the stock market last year are not
Home prices are expected to keep falling in '08. That means more mortgage defaults and financial pain for cash-strapped consumers, who account for 70 percent of U.S. economic activity.
More losses related to bad mortgages also suggest more write-offs to come at Wall Street banks, which have already fessed up to tens of billions of dollars of losses tied to securities backed by mortgages. The profit pinch at banks might also make credit less available to consumers and businesses, and that inability to access much-needed capital could further depress economic activity.
Then there's the pesky "R" word. Recession talk will grow louder, as will worries that less spending by U.S. consumers will put a dent in global economic growth, creating yet more headline risk.
In other words, stocks may be held hostage in the first half of '08 to the same uncertainties and fears that briefly knocked the market down more than 10 percent last year for the first time since 2002.
"The stock market will be volatile in the first half, very much like what we went through in the summer and late fall," says Rod Smyth, chief investment strategist at Wachovia Securities.
The biggest drags on stocks are likely to be a sharp drop in economic growth, or GDP, and deteriorating earnings, says Thomas Lee, head of equity strategy at JPMorgan Chase. "The economy will oscillate to stall speed," he says. "The impact on corporate profit growth will be savage."
Lee says GDP could turn negative, perhaps by a full percentage point, in the first half of '08. Corporate profit growth may go negative as well, he adds, with growth down 7 percent versus the same period last year. Smyth dubs this period of subpar growth as a "gro-cession."
Other risks facing stocks early in the year:
- Breaking through the November '07 lows. If weakness indicated by consumer discretionary and financial companies spreads to the broader economy, it could knock the S&P 500 below its lows hit in late November and mid-August (about 1407, 4.2 percent below the '08 close), says strategist Tom McManus at Banc of America Securities.
- Not getting rate cuts fast enough. With inflation far from dead, the pace of Federal Reserve easing likely will disappoint investors looking for a quicker economic boost, notes Abhijit Chakrabortti, U.S. global equity strategist at Morgan Stanley. "The market has too much expectations built in, not in the magnitude of the Fed cuts, but the pace of the cuts," he says. Chakrabortti sees the Fed lowering the fed funds rate, now 4.25 percent, to 3.5 percent at "a measured pace," probably in quarter-point increments. He says the Fed may also skip cutting rates a meeting or two in '08.
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Bearish indicators
1. Losses at U.S. banks mushroom.
2. Credit crunch intensifies, making it tough to borrow.
3. Growth in China slows, killing Asia boom story.
4. Housing prices fall double-digits, delaying recovery.
5. Economic growth stalls, causing recession.
6. U.S. consumers stop spending, crimping profits.
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2ND HALF
A market comeback is envisioned.
Wall Street, which is always looking out six months, will start to view the future more positively, the investment strategists say.
The fears of recession are likely to fade - thanks to profit-producing exports, capital spending by U.S. companies and a big assist from the Fed and foreign central banks, which will lower interest rates enough to jump-start the ailing economy and fuel growth, predicts Abby Joseph Cohen, chief U.S. investment strategist at Goldman Sachs.
"The S&P 500 is now priced for an ugly scenario. The fear now priced into stocks is likely to abate as recession fears fade," notes Cohen in her '08 investment outlook.
U.S. GDP growth could snap back to 3 percent after hitting a "speed bump" in the first half, says JPMorgan's Thomas Lee.
The negatives associated with the credit crunch, virtually a year old at this point, will start to recede. Capital injections from cash-rich foreigners will bolster the balance sheets of ailing U.S. banks, boosting confidence and paving the way for a recovery in beaten-down financials.
As a result, investors start to price in a better economy and earnings.
"The worst will likely be behind us, and if credit conditions improve, that will lead the market higher," Lee says.
A weak first half marked by falling stock prices will set the stage for a solid recovery, adds Tom McManus of Bank of America Securities.
"Enough time will have passed, and growing confidence that a recovery will occur in 2009" will set the stage for a year-end rally, McManus says.
Other catalysts that could catapult stocks higher in the second half of '08:
- Global growth story remains intact. If fast-growing economies in China, India and other developing markets keep chugging along, it will help offset weakness in the United States and prop up corporate earnings, says Hugh Johnson, chief investment officer at Johnson Illington Advisors.
- Profits perk up. Fears of negative earnings growth will start to ease as economic conditions improve in the second half of the year. Profit growth will resume. "We expect an earnings pickup in the second half," says Stuart Freeman, strategist at A.G. Edwards. "Our expectation is we have a 5.6 percent increase in earnings for the S&P 500 in the second half."
- P-E multiples will rise. With interest rates headed lower, investors will likely pay more for every dollar of corporate earnings, which will boost stock prices, predicts Lee. Price-to-earnings multiples will likely rise most for stocks with dependable profit growth.
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Bullish indicators
1. Central banks' push to lower interest rates works its magic.
2. Cash infusions from foreign governments to boost U.S. banks continue.
3. Global growth keeps chugging along, offsetting U.S. slowdown.
4. Price-earnings ratios expand, pushing stock prices higher.
5. Profit growth reaccelerates after soft first half.
6. U.S. banks say they've accounted for all their losses.
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