Earlier this month, I gave my eight general predictions for the New Year on financial markets, the Fed, housing, commodities and other important areas. The following summary will give my additional insight by sectors, but are subject to change as new news occurs throughout the year. I have given some highlights of bear and bull cases for each of the sectors and my personal take on each. Please note that these are simply highlights and other factors will also potentially affect each sector. I'll begin with a discussion of the consumer discretionary, consumer staples, energy and financials sectors, and then in my next public blog will discuss the remaining areas.
Bull Case: Thus far, the consumer been somewhat resilient, unemployment rates are at very low levels, stock prices in the sector are likely already pricing in a slowdown in consumer spending. Based on current expectations the Fed will continue to be active in providing liquidity into the sector, and housing could stabilize late in the year. Global growth will help prop up the U.S. economy, as valuations are becoming more attractive. Commodity price weakness could lead Americans to have more disposable income.
Bear Case: The housing market is very weak at the present time and many believe it will not bottom until 2009-2010. The mortgage crisis could continue to spread and affect credit card default rates and asset-backed securities. Consumer confidence could continue to deteriorate, and the economy could fall into a recession. Global economic weakness, increases in commodity prices could leave consumers with less disposable income.
My Take: This has been one of the hardest hit sectors during the second half of the year along with Financials. My view of the sector is that performance of many retailers will struggle at the beginning of the year but then improve as the year moves forward. However, as Daniel Carroll points out in his recent blog many of the big box retailers and specialty retailers have already witnessed significant price declines, and with a forward looking market this could potentially be a very strong sector during the final couple of quarters of 2008. My economic view is that we will have very slow growth during the 1st quarter that will pick up somewhat in the second quarter, and then we will return to normal GDP growth of 2.5%-3% during the second half of the year.
Bull Case: This industry is typically not affected by economic conditions as people will buy what they need. Continued globalization could lead to increased foreign sales or acceptance of new products, and commodity price weakness could lead to increased margins for consumer staples companies.
Bear Case: Valuations are somewhat above historical averages, and an improving economy in the second half of the year could lead investors to look elsewhere, protectionism could harm global sales.
My Take: I am neutral to slightly bearish on this sector due primarily to valuations in the sector and, in part, due to my belief that the U.S. economy will strengthen in the second half of the year.
Bull Case: Strong global growth will continue to drive demand for energy. Geopolitical risks will demand a premium for energy prices. Valuations of many energy stocks assumes much lower oil prices than what currently exists in the marketplace, while current supply/demand dynamics favor continued strength in oil prices as demand in emerging markets shows little in the way of decline.
Bear Case: Oil prices are near historic highs, and history tells us that when everyone is positive or negative on a sector we are nearing an inflection point. Slackening demand from slower global growth could improve the overall supply/demand balance, and emerging markets could start demanding less energy with slower growth rates.
My Take: It is important to remember that energy tends to be somewhat cyclical (energy stocks are typically one of the worst sectors in economic downturns). My expectation is that we will see a serious correction in energy price (and to a lesser degree in energy stocks) at some point during 2008 and then will likely see a bounce back towards the end of the year as growth picks up across the globe.
Bull Case: The financials sector has been the worst performing sector thus far in 2007, and therefore mean that reversion could lead to higher prices in 2008. Many of the stocks are trading at near historic lows in valuations. Further write-downs in mortgage securities are already priced into the valuations of financials, but not all companies in the financials sector have exposure to riskier assets, and some areas, such as insurance, will typically act very differently than money central banks or other financial sector stocks.
Dividend yields are very attractive in the sector especially as the Fed continues to lower interest rates. Global growth will lead to increased deposits, significant investments from overseas to shore up many of these companies. Bankruptcy laws which were changed a couple years ago, will result in less forgiveness of consumer debt, a widening yield curve, and strength in financial markets.
Bear Case: There is a deterioration in housing default rates and home sales. Increasing credit card default rates, overextended consumers, and the Fed being less proactive in lowering rates are leading to a flattening of the yield curve and the possibility of stagflation. Natural disasters are affecting the insurance industry. There is also increased asset market weakness, and increasing write-downs which are not yet priced into securities.
My Take: The financials sector has been one of the hardest hit areas of 2007. I believe that the market may not be fully pricing in all of the write-downs in the financials sector, however, much of this will be priced in during the beginning of the year, thereby allowing a strong bounce back in shares of financials stocks. My opinion is that the Fed will be proactive in lowering rates to improve the overall economy thus allowing for a wider yield curve allowing for improvements in the income from the spreads in interest rates.
In my next public post, I will discuss my opinions on the health care, industrials, materials, technology, telecom and utility sectors.