Thursday, January 03, 2008

Stocks Will Struggle in 2008

Following is my commentary from the January 2008 issue of the Forbes Growth Investor, which was released earlier to subscribers:

The stock market ended 2007 with a whimper. The closely followed S&P 500 Index managed to post only a 3.5% gain for the full year. Investors could have done about as well simply by holding cash and avoiding risk entirely. Although the other major indexes did somewhat better than the S&P 500 (see page 6 of newsletter for their full year returns), 2007 was a lackluster year overall.

Troubles in the housing market are largely to blame for weak stock returns. In fact, shares of home builders and financial companies were particularly hard hit during the year. As of now, prospects for stocks in 2008 do not look all that promising as the housing bubble has yet to fully deflate. According to the most recent reports, problems in housing are likely to get worse before they finally bottom. New home sales were down 34% year-over-year in November. Existing home sales were down 20%. If home sales continue at current rates, it will take more than nine months to clear the inventory of new homes on the market and more than 10 months to deplete the inventory of existing homes.

But it’s not just sales that are falling. Housing prices are collapsing as well. In October, the S&P/Case-Shiller 10-City Composite Home Price Index posted its biggest decline ever, falling 6.7% from a year ago and 1.4% from the previous month. This index is down 7.3% from its June peak. More worrisome, however, is that the rate of decline is accelerating.

All along, the more optimistic economists had been telling us not to worry. They said the sub-prime market was relatively small and its troubles would not spread to the rest of the housing market. They were wrong about this. What’s worse, it now appears that housing problems are spreading into nonhousing areas as well. Evidence is mounting that credit card delinquencies and defaults are rising. According to one study conducted by the Associated Press, outstanding balances on credit card accounts that are at least 30 days late jumped 26% from a year ago. Those that are 90 days late jumped 50%. The same study found an 18% increase in defaults. With the holiday shopping season having just ended, it’s a sure bet that these numbers will get worse.

Investors are just starting to realize that credit card problems are related to the housing and mortgage debacles. Because lending standards have been tightened, even otherwise creditworthy borrowers cannot easily tap the shrinking equity in their homes to pay off their credit card bills. And the so-called sophisticated institutional investors are less willing now than they once were to purchase securitized credit card loans.

Prospects for stocks in 2008 do not look good indeed. Housing and consumer spending are not the only things to worry about. Economic growth is slowing, yet persistently high energy prices and rising core inflation give the Fed little room to cut interest rates. Even the jobs market, which had long remained a bright spot in the economy, is starting to make investors nervous. Many economists now expect reduced growth in non-farm payrolls and an increase in the unemployment rate. The Dec. payroll figure and unemployment rate will be announced on Jan. 4. Anything out of the ordinary for either measure could create tremendous volatility for stocks.