Iffy 2008 outlook for Wall Street

A slowing economy may be a drag on corporate profits, some analysts say.

from the December 31, 2007 edition

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The pattern shows up clearly in forecasts for the quarter that ends Monday.

Back in October, analysts predicted that profits would be 12 percent higher in the fourth quarter than they were in that same period the year before. Now, says Mr. Butters, they're predicting that fourth-quarter profits will fall 9 percent over 2006's fourth-quarter earnings.

This backdrop appears likely to affect businesses' ability to create jobs and spend money on new facilities in 2008. Surveys of corporate executives, released earlier this month, show rising pessimism. In the latest monthly survey by CEO Magazine, only 16 percent of chief executive officers say they expect hiring to increase in the next quarter, while 41 percent expect a drop.

A separate survey of chief financial officers, by Duke University and CFO Magazine, found CFO optimism lower than during the 2001 recession.

If profits shift into reverse gear, it could also mean declines in share prices for investors, including those with pension and retirement accounts.

Such a reversal is possible, because of the slowing economy.

"Be prepared for a tsunami of earnings downgrades in 2008," economists at the investment firm Merrill Lynch warned in a recent report to clients. By their analysis of the overall business climate, profits appear poised to fall 7 percent in 2008.

Joseph Quinlan, chief market strategist at Bank of America in New York, says troubles in the domestic economy could overwhelm the gains from operations overseas – which in 2007 were enough to offset domestic losses. The problems include a housing slump and a related squeeze in banking and credit.

"It's a workout process," Mr. Quinlan says. "It's going to take some time."

Some analysts say investors should be ready to see a bear market in stocks – perhaps early in the new year – followed by a recovery later in the year if the economy appears set to pick up.

Others, though, say share prices could rise despite a cooling economy. For one thing, current stock prices already reflect some expectation of bad news.

Abby Joseph Cohen, market strategist at Goldman Sachs, recently forecast that the S&P 500 index will end next year at 1675, well above its Friday close of 1478. A key reason behind the investment firm's call: Stocks are already priced for a cooling economy and could rise if things simply go OK. Ms. Cohen predicts 1.8 percent growth in the economy next year, profits rising by 5.6 percent, and inflation of consumer prices at a relatively tame 3.5 percent.

"There are indeed some very ugly scenarios lurking in the background that cannot be dismissed out of hand," she writes with other Goldman strategists. But they predict that "US stocks will offer moderate gains."

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