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Risks Will Rise, But So Will Stocks

12/17/2007 12:00 am EST


Jim Lowell

Senior Partner & Chief Investment Strategist, Adviser Investments

James Lowell, editor of Jim Lowell’s Fidelity Investor, says the risks of recession are rising, but that won’t stop stocks from having a nice year-end rally.

The more the Federal Reserve signals its willingness to manage the markets and not just the underlying economy, the more positive the tone in the markets will likely be. In so far as we can’t rule the Fed’s role out of the markets, we can’t rule in only downward pressure on them. Still, if this market is only swinging on the hinge of rate-cut expectations, I’d say that’s a weak hinge on which to hang sustainable higher highs.

This year, despite known swings that would have made Tarzan lose his grip, the vines that have borne the most performance remain those attached to foreign branches of the global marketplace. As we wind down 2007 and look into 2008, I suspect that pattern will remain, but I also suspect that if our economy cracks into a recession, the global markets will crack into a correction of similar magnitude to our own market’s moves.

Moreover, if the US goes into a recession, look for the oil-rich Arabians and the dollar-rich Chinese to continue to build stakes in the largest, safest, most liquid and vibrant marketplace: our own.

One indicator that recession isn’t too far down the road is recreational vehicle (RV) sales. (I’m not kidding.) Bloomberg sums up this bellwether indicator best: “For the past three decades, deliveries of motor homes and travel trailers have dropped before each decline in the US economy.” RV sales are off this year and forecast to continue to slide in 2008.

At the end of November, Goldman Sachs upped its odds for a recession to 43%—still below 50/50—and they now posit a probable 3% Fed interest rate by mid-2008. (The Fed itself had a similar view, expressed last month when chairman Ben Bernanke upped the odds of a recession to 45%.) 

While I’ve been saying nearly year-long that I think the threat of recession is around 35%, [I’m revising my estimate of] the risk of recession to 45%—not quite 50/50, but heading in the wrong direction.

Still, as Black Friday came and nearly 150 million buyers went, Cyber Monday surged and sent nearly a $1-billion message that consumers are increasingly comfortable with letting their fingers do the walking. Net, net, I’d bet the consumer spends between 5% and 10% more on holiday gifts this year compared to last—but the benefits will accrue to the consumer more than the manufacturer or retailer.

[But I think] a “Santa Claus Rally,” which refers to a seasonal phenomenon of stocks rising between Christmas and New Year’s, is likely. This rally is explained by both year-end window dressing and getting a jump start on another trend known as the “January effect” (wherein stocks, especially small-cap stocks, have a pattern of rising on the first five trading days of the New Year). This year, the November correction and rebound [could] set the stage for a month- and year-end rally that will leave us feeling merry and bright.

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