The fourth quarter of 2007 was characterized by a worsening of the subprime mortgage crisis, which has caused some major disruptions to the credit and financial markets, resulting in a contraction of the availability of credit worldwide. This, coupled with a greater than expected housing recession in the U.S., is likely to result in a slowdown of both domestic and international growth in 2008. The U.S. housing downturn is deeper than anticipated, likely to continue, and its after effects will be felt into 2009 as ARM resets continue to pressure mortgage holders. Surprisingly, retail sales volumes have held up quite well, but conditions now suggest that consumer spending will be impacted next year.
The sectors hit hardest by these two crises were financials and real estate. The outlook for them remains uncertain in the near term, especially in the case of the financial sector. Interbank lending rates remain high and it remains to be seen how long it will take them to normalize. When they do, there may be some good investment opportunities in the financial sector. However, the effects of the subprime mortgage crisis on bank balance sheets may overhang well into 2008. Mortgage foreclosures also may accelerate in 2008 and 2009 as more than 2.5 million subprime mortgages reset to levels considerably higher than their “starter” rate. Many of these borrowers have little equity in their homes.
Against this backdrop of tighter credit and weakening growth, housing prices are likely to continue falling throughout 2008 and consumption will weaken. Despite inflationary pressures from higher commodity prices, inflation should now remain moderate because some 40% of U.S. inflation comes from the housing sector. This will permit the Federal Reserve to continue cutting interest rates aggressively throughout 2008, as well as the Bank of England and the European Central Bank.
While Brent crude oil approached $95 per barrel, the dollar hit new lows against other major currencies, and gold hit new highs. The low level of the dollar today will help U.S exporters, which will prove to be a bright spot for the U.S economy going forward. Geopolitical risks will continue to increase in 2008, accompanied by a new awareness and aversion to risk by global investors. Although we believe that a recession is still unlikely, we exercise caution in our stock market outlook and would not be surprised to see a continuation of a pullback in equity prices in the first quarter of 2008.
For the year, the Dow gained 6.4%, The S&P 500 rose 3.5%, and the Nasdaq was up 9.8%.
Grant Rogers Elizabeth Allen
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Posted on 12/31/2007 at 12:00 AM
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