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Tuesday, 1 January 2008

2008 outlook: Fasten your seatbelts

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

NEW YORK (CNNMoney.com) -- 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.

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.

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.

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.

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