2008 outlook: Fasten your seatbelts

[usakos]

Market strategists expect a volatile year for stocks and that the housing market will swoon. Sound familiar?

Wall Street's top forecasters have some good news and bad news for 2008. Many think stocks will head higher but that unemployment will rise and the overall economy will slow.

In other words, 2008 is going to look an awful lot like 2007. Despite falling housing prices and the subprime mortgage meltdown igniting fears about a broader economic slowdown, stocks are still on track to finish higher in 2007.

For 2008, experts said investors need to be prepared for more woes in the slumping housing market and a slight rise in unemployment.

"2008 will be a sluggish year," Abby Joseph Cohen, Goldman Sachs' chief U.S. investment strategist, told CNNMoney.com. She said many investors are concerned about what could be weak earnings growth in 2008.

"Portfolio managers sense that 2008 will be a very difficult year for corporate profits," she said.

But Cohen believes that stocks could finish 2008 in the plus column as investors anticipate better news in the latter part of the year.

"We believe that the worst time is right now. The worst numbers will be at the end of 2007 and in the first half 2008. We expect an improvement in the second half," she said.

Fortune's best stocks for 2008
Cohen isn't the only strategist who feels this way. Research firm Thomson Financial pointed out in a recent report that Wall Street analysts expect profits for the S&P 500 to increase in just the single-digits in the first two quarters of 2008 but that overall earnings for the year will be up nearly 15 percent.

With this in mind, Cohen expects the Dow Jones industrial average to end the new year around 14,750, a gain of more than 10 percent from current levels, and that the S&P 500 will close at 1,675, up nearly 14 percent.

Analysts at Thomson Financial are predicting a more modest rise for the market, however. The firm believes the S&P 500 will end at 1,580, a gain of 7 percent.

Still, how can stocks have a good year if so many market strategists are predicting a rough year for the economy?

In a recent report, Cohen wrote that the market is relatively cheap when compared to previous periods of comparable inflation and that stocks are priced for the worst case scenario, i.e. a recession.

But Cohen thinks the economy will not slip into a recession. And one big reason for her optimism is that she thinks the Federal Reserve is likely to keep lowering interest rates in order to make sure the economy doesn't grind to a halt.

Investors like interest rate cuts since they tend to lead to more borrowing by consumers and businesses, which in turn helps to boost economic activity and corporate profits.

"Recent speeches and policy actions suggest that the Federal Reserve is paying close attention...to the smooth functioning of markets and recession avoidance," Cohen wrote.

The Fed cut interest rates three times in the second half of 2007, lowering the key federal funds rate from 5.25 percent in August to 4.25 percent by the end of December.

Economists at Lehman Brothers wrote in a report that they expect the Fed to cut rates several more times in 2008, perhaps to as low as 3.25 percent. The Lehman economists suggested that the economy "may bend but not break" in the new year.

How they got housing wrong
But much of 2008 could be rough. Though the economy is expected to begin to rebound later in the year, economists believe that the slumping housing markets and credit crunch will continue throughout at least the first half of 2008.

Standard and Poor's predicts that the housing market will not finally bottom until October.

Home prices are expected to fall 11 percent over the course of 2008, according to Standard & Poor's.

As the housing market continues to slump, economic growth is expected to slow in 2008. This year, gross domestic product, or GDP, was aided by a strong third quarter, and analysts believe that at 2007's end, the economy will have grown 2.2 percent from the close of the fourth quarter in 2006.

At the end of 2008, however, Lehman Brothers predicts 1.8 percent overall growth, and Merrill Lynch believes that GDP growth in 2008 economy will be only 1.4 percent. Thomson Financial more optimistically expects GDP to grow between 2 percent and 2.5 percent over 2008.

Many analysts point out that although the economy and housing market will struggle in the new year, this may not necessarily result in recession.

Hiring in '08: Slower but steady gains
But other economists warn that there is still a high risk of recession. "We are at the brink of a recession," Standard and Poor's senior economist Beth Ann Bovino told CNNMoney.com. "We are certainly concerned about the 2008 economy."

Standard and Poor's thinks there is a 40 percent chance of a recession in 2008.

And as the economy slides in 2008, unemployment is expected to increase as well. Standard & Poor's is predicting an unemployment rate of 5.2 percent by the end of 2008, up from the current rate of 4.7 percent. Goldman Sachs expects the unemployment rate to be between 5.5 percent and 5.8 percent.

Nonetheless, Goldman Sachs' Cohen thinks consumer spending and confidence will pick up in the second half of 2008, despite the rise in unemployment.

And analysts at Thomson Financial wrote that they also think the consumer will stay afloat. The firm is forecasting monthly same-store sales growth of about 2 percent to 5 percent throughout the year.

So even though the financial headlines for 2008, particularly the ones about the housing market, may be as scary as the ones from 2007, many investors and consumers could do reasonably well. Just like in 2007.

Read more at CNNMoney.com at Buckle up, it could be a bumpy 2008 - Dec. 31, 2007

[rlmedia]

Well, find a way to overcome this and your a rich man/woman but I don't think the Federal Reserve will let that happen

Don't worry about problems, think towards ideas.

[BusinessAdviser]

So how does everyone think that the Fed affects the economy?

[usakos]

I think the fed was slow in responding to the housing market crunch.

[BusinessAdviser]

But does the rate ITSELF actually affect the economy that much, or is it the difference between consumers' expectations of the Fed's actions and the Fed's actual action? These are two different theories of how the Fed Rate affects the economy, and I'm curious to know what others think.

[usakos]

Well, the interest rate cut helps increases the interests of the consumer and businesses to borrow more money, thus injecting money for spending in the economy, but they also have to be careful not to cut it too low in order to avoid inflation.

[BusinessAdviser]

Yes, I understand this, as most individuals who have taken a Finance 101 class do. And this is a very important understanding that everyone should no. But what I'm asking is:

Are the effects of the Fed's rate cuts, for example, due to the actual cuts themselves, or to the difference between the economy's expectations of the cuts and the actual cuts that the Fed institutes?

These are two different theories that serve as bases for positions on how the Fed should take actions.

[usakos]

I think it all depends on the expectations and not so much on the actual Fed's rate cut. Most people tend to not like uncertainty. And since 2001, the economy never really recovered. People are still not sure what's going to happen next.

Iran, North Korea, etc., and now Pakistan, all these still play a big role of uncertainty, and what's happening elsewhere in the world certainly affects how we feel and spend here in America. Americans have money, but most just don't want to spend it because of some of these uncertainties, and even though the Fed may cut the rate, the consumer will still not borrow as expected.

Pakistan has 60 nuclear weapons, which no one really knows how secure these can be or some may end up in the hands of those who hate peace and advocate hate and violence.

This Christmas, has not really been like any other past Christmases, consumer spending and expectation were still low. Not because of weather or whatever, but simply because people are just not certain.

And ever since Bernanke took over, I just never had any trust or hope in him. Greenspan was more effective and he still is. When he spoke, everyone listened, and I think that too plays a role - the faithless and trust less in his leadership.

[BusinessAdviser]

I think it all depends on the expectations and not so much on the actual Fed's rate cut. Most people tend to not like uncertainty. And since 2001, the economy never really recovered. People are still not sure what's going to happen next.

There you go! I'm in agreement. I tend to think that the effect of rate cuts, at least in the short- to mid-run, is basically a result of the difference between the actual cut and what people expect.

For example, if the "experts" are expecting a 0.5% cut, but the Fed only cuts rates 0.25%, even if the 0.25% might be sufficient, in the eyes of the Fed, to effect its goals, stock prices will immediately fall and everyone will fear that we're headed for a recession.

I, like you, think that the specific percentage rate cut made by the Fed is rather unimportant, when compared with the Fed's deviation from public expectations. Thus, the Fed must look mostly to Wall Street's expectations to determine how much to raise or lower the rate. If the economy is too active and therefore inflation is rising, the Fed must base its rate hike on what the public EXPECTS the Fed to do. If the public expects the Fed to raise rates by 0.5% but the Fed only raises it by 0.25%, even though the Fed raised the rate, the effect will ACTUALLY result in increased activity and inflation.

Thanks again for the great response.

[usakos]

There you go! I'm in agreement. I tend to think that the effect of rate cuts, at least in the short- to mid-run, is basically a result of the difference between the actual cut and what people expect.

For example, if the "experts" are expecting a 0.5% cut, but the Fed only cuts rates 0.25%, even if the 0.25% might be sufficient, in the eyes of the Fed, to effect its goals, stock prices will immediately fall and everyone will fear that we're headed for a recession.

I, like you, think that the specific percentage rate cut made by the Fed is rather unimportant, when compared with the Fed's deviation from public expectations. Thus, the Fed must look mostly to Wall Street's expectations to determine how much to raise or lower the rate. If the economy is too active and therefore inflation is rising, the Fed must base its rate hike on what the public EXPECTS the Fed to do. If the public expects the Fed to raise rates by 0.5% but the Fed only raises it by 0.25%, even though the Fed raised the rate, the effect will ACTUALLY result in increased activity and inflation.

Thanks again for the great response.

Kein Problem!

Alles ist in Ordnung.

[BusinessAdviser]

However, I'd be interested to know if anyone will argue in favor of another explanation.

[Aletheides]

The Federal Reserve destroys the economy.

See this graph tracking inflation.

http://www.economics-charts.com/imag...-1800-2005.png

Notes:
-Federal Reserve inception 1913.
-USA went off the gold standard in 1933
-Notice how the peaks in inflation over the last 200 years have coincided with major wars.

For 2008, I predict a bad year. The economy works in cycles, and we are due up for a nice recession.

[BusinessAdviser]

The Federal Reserve destroys the economy.

See this graph tracking inflation.

http://www.economics-charts.com/imag...-1800-2005.png

Notes:
-Federal Reserve inception 1913.
-USA went off the gold standard in 1933
-Notice how the peaks in inflation over the last 200 years have coincided with major wars.

For 2008, I predict a bad year. The economy works in cycles, and we are due up for a nice recession.

Very interesting theory. Yeah, I think "interesting" is all that can be said about it.

Data mining is NOT support for a conclusion. (Data mining - sorting through large amounts of data and picking out information.) For example, identifying a trend of rising inflation and identifying an event that occurred at the same time as the start of the trend, for the purpose of explaining the trend is data mining and is not reliable support. Arguing that the "Federal Reserve destroys the economy" due to the Federal Reserve Act being passed at about the same time as the start of an inflation trend, is just as reliable as arguing that the assembly line destroys the economy, since Henry Ford began the first moving assembly line in 1913 as well.

Try giving a REASONABLE argument for how the "Federal Reserve destroys the economy," and add to the intelligent discussion.