My 2008 Investment Prognosis

Consider this - the U.S economy has slowed down from a quarterly annualized growth rate of 3-4% to about 1% in Q4 2007. With all my due respects to Larry Kudlow & company, I would bet safely that we are clearly facing the start of a period of economic slowdown in the U.S.

If markets behave the way they usually do, here's my prognosis for 2008:

1. The U.S housing market would face prolonged slowdown at least until the end of Q3 2008. With more ARMs resetting over the next few quarters, subsequent delinquencies and further write-downs of bank Level 3/sub-prime assets as home prices continue to fall, there's enough negative momentum left for another 2-3 quarters.
2. Negative fall-out from the housing market will impact consumer spending in a bigger way in Q1 and Q2 2008. Consumer spending (accounts for 2/3rd of Gross GDP) slowdown will eventually affect corporate spending and capex, and the job market by Q2 2008. We should expect to see job market contraction around late Q1-mid Q2 2008.
3. Despite the magnified effect of the housing market on th economy, global economic factors (continued growth in Europe, Asia & Japan) would help the U.S to avoid a recession next year. This would mean sustained 1-2% growth numbers for most of 2008.
4. Emerging markets, primarily India & China, would face significant stock market corrections around Q3 2008. Slow down in U.S growth will eventually affect certain sectors in these economies, forcing corrections in market valuations. Market PE in India, for example, would drop from ~22s to ~18-19 in the medium term.

What does this all mean - where to invest & where NOT to invest in 2008? [Stocks, Bonds, Real Estate....]

US STOCKS

• Contrary to perception, the US financial services sector will in fact MODERATELY OUTPERFORM the market in 2008. Most of the negative news has already been factored in, and any positive news would create significant upsides. Stocks to watch for significant gains: Citigroup (C) (far more resilient due to global presence. Sub-prime write-down impact has been over-played by the market. Expect Vikram Pandit to take some drastic steps to address operational efficiency issues), E*Trade (ETFC) (Inherent strength of the original business model will help hold customers. It's fire-sale of high-risk assets to Citadel will cushion earnings impact for the next 2-3 quarters and help ride over the current crisis). However, in this sector, you need to have a 6-12 month time horizon for Q1 investments!
• Oil, Heavy Engineering, Automobile stocks will face significant pressure as the slow-down spreads to the broader economy. Avoid Caterpillar (CAT) and Exxon Mobile (XOM).
• Technology stocks including darlings like Apple (AAPL) and Microsoft (MSFT) will face pressure by Q2 2008 due to broader economy slow down - their continued strength in Q4 2007 is more due to lag effects associated with a slow down than anything else!
• Commodity stocks [notably Goldcorp (GG)] MIGHT see significant gains over the next 4-8 quarters. However, the recent bull run in these segments will force near-term corrections. So, get in only after a significant correction - and only if you thrive in volatility!
• As in any slowdown scenario, staple-consumer and pharma stocks will hold strong. Notables - Johnson & Johnson (JNJ), Bristol-Meyers (BMY), Coca-Cola (KO), Procter & Gamble (PG).

Other Investments

• As you would have figured by now, stay OUT of the U.S housing market (from an investment perspective) till end of Q3 2008. We should see the bottom by late 2008, though it will be a slow climb up from there!
• Avoid increased exposure to emerging market stocks and funds. As mentioned above, these markets would be negative-to-neutral on an annual basis in 2008, and will face significant medium term corrections. An interesting pick - Indian offshore providers [Infosys (INFY), Wipro (WIT), Cognizant (CTSH)] will have positive momentum as rupee appreciation is contained in 2008 (~5%) and U.S economic slowdown pushes more offshoring to India and China.
• The real estate sector correction in US & ripple effects on the global economy will force corrections to real estate market in emerging market economies (India being a notable example). However, we will see continued growth in Tier II/III business centers in these economies, as businesses relocate and overall demand remains stable/upward.
• As the U.S economy slows down and its ripple effect on the global economy starts felt by Q3-Q4 2008, there will be a continued flight of money to safer quasi-sovereign investments. Expect to see abnormal returns on high-grade bond investments (treasuries, high-grade munis, AAA corporate etc) over the second half of 2008 and extending well in to 2009, as even emerging market and European economies are forced to cut benchmark rates to push continued growth. Try parking some money in income funds with a heavy focus on high-grade paper.

"As in everything, investing is an art and we learn more as we know more."

More to follow....stay with me to track markets as we step in to a brand new year!

Disclosure: none

Comments

[thinking ahead:]

CAT is trading at 13X with a 10-15% growth rate as far as the eye can see. It also pays 2.1% dividend yield, and has a steady record of dividend increases. It also is buying back stock and sales are 60% non-North America. CAT is not a housing play or a US consumer play. Maybe it was 10 years ago, but now it is more sensitive to Brazil (on the ground over 30 years there) than to Toll Brothers. (dics: I'm long CAT)

2008 Jan 11 10:24 AM

[Scott Weitz:]

Nice article...I agree with most it. Love the ETFC pick..the risk/ reward at these levels is terrific.

2008 Jan 11 06:15 PM

[TA:]

Excellent article, so nice to find someone with a brain making 2008 predictions

Nice balance to the same bear crap I have wade through on this site from Dr Enzio, Trader Mark, Thomas Tan, Barry Ritholtz and other idiots

2008 Jan 11 08:15 PM

[kkin365:]

So far, your predictions do not seem to be bearing fruit. Both KO and PG were down Friday (1/11). We'll know more about C comes Monday (1/14). GG is up, but this is just conventional wisdom at the moment. Would it be up for another 4-8 quarters -- two years -- without correction? Too vague for my taste.

2008 Jan 12 11:26 PM

[Promod Radh...:]

KO, PG, JNJ, MO are all long-term bets over a 6-12 month period of sustained slowdown...its an old theory, where non-cyclicals do well in periods of down turns. GG might see intermittent spikes, but depending on your view on commodities over the next 2-3 quarters (I am bearish to neutral), it would correct. Eitherway, its going to be a very volatile ride for folks holding Newmont, Goldcorp etc.

2008 Jan 13 09:52 AM

[User 111984:]

very good article. thank you.

2008 Jan 22 12:38 PM