Stocks and Bond Market Forecasts for 2008

By: Paul_J_Nolte

Vacation and holidays have prevented the usual writing of the newsletter, so this will serve as the annual prognostication letter. First, the markets should start the year weak, employment will be poor and bond yields will be at their lowest in 4 years by mid-month. Oh, that has already happened…not bad predicting so far! The rest of the year won't be as easy, especially for financial markets. The persistent news revolving around credit and availability, write-offs and housing inventories should keep the markets on the defensive for much of the year. Last year we predicting a poor market – we were wrong until August.

This year we are rolling out the same prediction, with a twist – the first half should be the worst, with the back half actually looking pretty good. For the full year, we still see poor performance, but once past the mid-point we should begin benefiting from the rate cuts and we should also begin seeing the easing of credit pressures. Volatility will remain this year – so 150+ point moves in the Dow will be regular occurrences. Rallies early in the year should be used to reduce equity exposure for investors who don't want to see a decline of 10-15% from current levels.

The weakness in the economic numbers to start the year was enough to put our modeling into a recessionary window that we haven't seen since 2001-'03. Broadly speaking, the equity markets do very poorly during recessionary times, falling between 20-30%. Since we have already dropped 10%, another 10-20% is likely in the offing. Earnings, which peaked in August, have declined by 7.5% and should fall further on the back of very poor earnings from the financial sector. Sentiment, as measured by Investors Intelligence, has declined from the peak, but remains well above even the levels seen at the August low.

Our technical models are pointing to a modest relief rally, but our longer-term models have not yet reached levels that point to a meaningful bottom. If we are drawing up the playbook for the next few months, we should see a few sharp and short rallies that could push the averages up 3-5 over a few week period before rolling back over and proceeding to fresh lows. The key for the SP500 remains the 1370 level that marked the bottom in both March and August. A break of that level should confirm a new (lower) trend in the markets that could push the SP500 toward 1200 (from current 1400).

The bond market has been celebrating the weakness in stocks, with the 30 year bond near record lows and short rates (save for the '01-'03 decline) at a point where they turned higher in '93-'94. What makes this period very different is that a lower rate environment may not create demand for goods or real estate that could pull us out of recession. The risk is that much lower rates will inflate another asset class, as happened after the '94 lows (tech) and '01-'03 (real estate). Commodity prices continue to believe that the global economy remains strong, however any weakness in the global (especially emerging markets) economy could force commodity prices significantly lower.

By Paul J. Nolte CFA
http://www.hinsdaleassociates.com
mailto:pnolte@hinsdaleassociates.com

Copyright © 2008 Paul J. Nolte - All Rights Reserved.
Paul J Nolte is Director of Investments at Hinsdale Associates of Hinsdale. His qualifications include : Chartered Financial Analyst (CFA) , and a Member Investment Analyst Society of Chicago.

Disclaimer - The opinions expressed in the Investment Newsletter are those of the author and are based upon information that is believed to be accurate and reliable, but are opinions and do not constitute a guarantee of present or future financial market conditions.

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