I am fully aware that the calendar is only a benchmark of time, some way to delineate one event from another. That said, should 2007 really be much different than 2006?

We were witness to a year of record setting gains on the Dow, an equity indicator that is at best a billboard of enthusiastic deception. Surely the only way someone might be negative towards such unbridled optimism would be the result of sitting on the sidelines as the index gained over 1500 points.

The Dow Jones Industrial Average gained 16.3% for the year. This was an impressive feat. With 912 trading sessions without a 2% decline (read: without a healthy correction), even the most optimistic investors should be concerned. International stocks surged 23% while the S&P 500 racked up an impressive 14.5% gain for the year. 

Yet, the most telling sign was in the surge of value related stocks (18%) as compared to the gains posted by the growth sector (8.3%). Growth, the barometer of company strength and profits did not materialize for investors in 2006 and that particular sector seems poised to do much of the same this year.

An underlying theme for much of the optimism over the past year was based on the perceived value of the stock. Stock buybacks reached record levels in 2006 topping $435 billion. (This number topped capital spending during the same period.) Inexpensively borrowed money used to purchase shares on the open market only served to increases the price side of the price to earnings ratio, the go-to piece of data used by the majority of investors. 

What worked on ’06 to generate investor interest might meet with increased skepticism and possibly even some profit taking in ’07. 

Risk in 2006 was not much of a consideration. That allowed herd mentality to rule the trading desks around the world. Companies posted another year of profits that were cloaked in tax breaks, merger and acquisition activity, and the calm demeanor of the Federal Reserve gave investors a false sense of hope. 

We believed and we pushed stock prices ever higher. Which would make optimism our first concern heading in the New Year. As students of the market already know, optimism is freedom from any anxiety related to risk. 

Turning away from a banner year in gains is no easy feat. Conflicting economic data throughout the year was easily reasoned away or revisited/revised/recalculated when the following month’s report was issued. There was no validity in short-term information yet investors read the tealeaves and kept pouring more money.

That sort of ‘bottom-of-the-cup’ prognostication came in a year free of major weather complications, a predictable central bank whose concern over inflation masked a White House based agenda of a fully deregulated business environment and a weak dollar.

Weather-free investing still allowed oil to reach beyond sixty dollars a barrel. By the fall, those high prices were a non-event. Prices that were passed through to other businesses and eventually consumers went up so gradually that even the inflation hawks missed it. 

(You can factor those oil prices into almost every corner of the economy. Hiding it takes skill. Take an ounce from a box of cereal and you still have a box of cereal with the same price point – and no inflation.)

We can shrug our collective shoulders at the tension in the Middle East and downplay the risk of a nuclear Iran, further deterioration in Iraq, and the maniac in North Korea but they cannot be ignored in 2007. Oil shock could come as a result of any of these country’s ambitions and the world’s reaction.

We can ignore the bond yields and the fact that hedge funds continue to push the envelope of what would be considered sound investing. Eventually, fear based investing will filter over to the equity investor. Only in the stock market, where fear seems to manifest itself as a missed opportunity, will buyers pay continually higher prices for the belief that they will be able to gain their fair share of the run-up. 

Optimists will be convinced that inflation will have no effect in 2007, businesses will find new ways to create profits, and the growing inequality of wages coupled rising insurance costs and falling residential equity will stay marginal.

Investors in commodities should be wary of several global developments in the coming year. The resource grab will continue and as a result prices will go up predictably and down. Any number of reasons will come into play in the coming year demanding steely nerves but several stand out.

Should commodities come under pressure from better environmental controls or as Niall Ferguson, history professor at Harvard University calls it, resource nationalism, should the US economy slow, should investment shift from stockpiling to investment growth in politically suspect parts of the world increase, should countries such as China create resource colonialism among third world suppliers, investors can count on another year of volatility.

Yet Mr. Ferguson believes that history will eventually drive prices down shifting the power from the suppliers (and countries vying for alliances) to the end customers, a global economy in need of fair prices.

It remains to be seen how investors react to closer scrutiny of the markets. The record-breaking run-up was not much to brag about when you begin to separate the winners from the losers. The DJIA rose to those new levels with less than eight members of the index actually ending the year with new highs.

In 2007, you can expect the field to narrow further in the coming year. The economy will slow and the Fed will let rates drop. Enthusiasm will wane and a mild recession will take hold. There will be business-averse repercussions from the Democratic Congress that favor labor. Henry Paulson, Treasury Secretary will continue his quest to drop regulatory hurdles for foreign investment (a concession the House Finance Committee might find itself willing to grant) and Christopher Cox, chairman of the S.E.C. does his part by dismantling Sarbanes-Oxley. The consumer will struggle (more on that segment of the economy later) in 2007, a belated reaction to the events of the previous year.

If you can honestly say to yourself that your portfolio out performed the S&P 500, something investors are not likely to be when called upon for frank self-examination, then you were very lucky indeed. If you can honestly say the same thing at the end of 2007, you will be doubly fortunate.

© 2007 Paul Petillo
Editorial Archive

CONTACT INFORMATION
Paul Petillo
Blue Collar Dollar.com
Portland, OR USA
(501) 313-5252
Email  |  Website