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Economic Realities - Fourth Quarter, 2007

Dan Junkin

As we peer into 2008, there are several big questions which will have an impact on the markets and the economy:

  1. What are the contours of this election cycle?
  2. What about the housing situation
  3. The price of oil?
  4. What about the situation in Iraq, Iran, Afghanistan and Pakistan?
  5. What about the fixed income markets?

That list is not in order of most important to least. Rather, I think these issues are going to occupy the various news outlets this coming year — in order of most attention to least. Like it or not, we do live in a media — oriented world and we will hear a lot about these issues this year. And how we react to the news will affect how — as investors and consumers — we make our decisions this year.

I have not listed the stock market in the list of questions — nor the possibility of a recession. The stock market seems to be standing back and watching how we answer the first five questions. Indeed, corporate profits are still relatively robust and — in the most meaningful ways — that is the meat and potatoes of the stock market. And yet, the various equity indices have been extremely jumpy since the end of the second quarter of last year. And the possibility of a recession depends — in large part — upon how we perceive the five issues are turning out.

Voters do seem to be hankering for change — witness the results of Iowa. If voters believe that their desire for change is respected, that is positive for the nation's mood.

Housing is more difficult to decipher. The seeming bad news that new housing starts are significantly depressed is, in fact, a good thing — since that will help us digest the overhang of houses on the market. I suspect that we will not begin to feel better about housing until late fall or the end of this year. This will continue to nag consumers and investors — although its news value will gradually decline.

I expect the price of oil to retreat from the scary $100 level in the first half of this year — to perhaps the mid $80's range. This will result from some increased production and slightly reduced worldwide demand. Beyond mid year, it is hard to predict. However, the long term trend is decidedly up. This will be a mild net positive for the year for consumers and investors.

Iraq has turned into — at least — less of a daily bad news item. And the same for Iran. But Afghanistan and Pakistan may become the Iraq and Iran of last year. This area is likely to keep us rattled this year and beyond.

The fixed income markets are being driven by fear and reality. Fear that there is more sub-prime than we know about. And daily we confront the reality of distortions in the markets driven by those fears. I have a sense that we have seen most of the worst and that this news item will also begin to recede. Fixed income markets should resume more normal patterns the further we go into this year.

Obviously, some new issue may suddenly transfix voters, consumers and investors. Absent that, I believe that we will slowly feel better during the coming twelve months. Thus, I do not expect a full fledged recession — although, some parts of the economy will feel pretty recession like. I believe that the US stock markets will have a modestly OK year (probably resulting in a single digit positive total return). High quality fixed income will be a good area — however, mortgage-related securities will still have a tough time.

If you would like to discuss these or other issues and how they might affect your investments, please don't hesitate to contact us.

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