No bull lives forever. Not even the wealth-building Wall Street variety. But if the current bull market, now 5 years old, can stay alive one more year, it will accomplish what the mighty bull of the late 1990s could not: six consecutive years of gains.
That's not to say this bull market, even if it finishes higher in 2008, is in the same league as the '95-through-'99 bull, a moneymaking machine that transformed the Standard & Poor's 500 from a little-known stock index into a household name. The S&P 500 tallied gains of 220% in the '90s run, posting annual returns in excess of 20%. In contrast, the current bull, which rose 3.5% in 2007, is up 67% since the end of 2002.
If this bull is to rival the performance of the '90s juggernaut — or match the eight-year winning streak from 1982 through 1989 — it must overcome stiff headwinds in 2008.
The obstacles confronting Wall Street are well-known and well-publicized: Falling home prices. Rising mortgage defaults. A flood of foreclosures. Tougher loan standards. Tighter credit. Tapped-out consumers. Inflation pressures. Slowing profit growth. Recession fears.
All this, of course, could mean tough times ahead for the stock market.
Much of the bad news, however, might already be reflected in stock prices, paving the way for gains again in '08, says Bill Stone, chief investment strategist at PNC Financial Services Group.
"The market," he says, "has priced in all but the ugliest of outcomes."
Indeed, while the risks mentioned are real and pose a major threat to the stock market, there are also many potential tailwinds that could propel stocks to another positive year in 2008. Those would-be drivers, in no particular order, include:
•The dawn of a brighter future. A lot of bad news is now priced into the stock market. If the storm clouds clear and investors start pricing in a better environment six to 12 months down the road, as they typically do, a rally may materialize.
"Once investors turn their attention to the brighter future that exists on the other side of the current housing and mortgage abyss, stocks are likely to rally," notes Timothy Swanson, chief investment officer at National City Private Client Group.
•Interest rate relief from central bankers. In an attempt to keep financial markets running smoothly and to shield both the U.S. and global economies from the negative fallout from the mortgage crisis, central banks around the world, including the Federal Reserve here in the USA, will continue to lower interest rates, predicts Jeffrey Applegate, chief investment officer for Citi Global Wealth Management.
"Central banks are alert to the issue and want to keep the U.S. out of recession," he says.
The Fed has already reduced the fed funds rate — the interest rate banks charge one another for overnight loans — by a full percentage point to 4.25% from 5.25%. Central banks in Canada and London have also been lowering rates.
While the U.S. stock market is still trading more than 3% below the level it was on Sept. 18, the date of the Fed's first rate cut in this cycle, history suggests the market will eventually perk up thanks to lower rates. "The greatest gains usually come during the second half of the easing cycle," says Paul Hickey of Bespoke Investment Group.
•Capital infusion from foreigners. A big investor concern has been the fear that credit might tighten up severely due to the massive hits to the balance sheets of major U.S. investment banks from losses caused by the mortgage meltdown.
But much-needed capital to shore up balance sheets is coming from an unexpected source: cash-rich foreign governments such as China, Singapore and the Middle East. These so-called sovereign funds, once distrusted, "have become saviors" by injecting badly needed capital into the global financial sector, notes Joseph Quinlan, chief market strategist at Bank of America's Global Wealth & Investment Management group.
"In 2007, sovereign wealth funds emerged as a source of financial stability rather than instability," Quinlan says.
In late November, for example, a Middle Eastern sovereign fund bought a $7.5 billion stake in Citigroup. In early December, China pumped $5 billion into Morgan Stanley. More recently, a government-sponsored investment fund from Singapore took a $5 billion stake in Merrill Lynch.
That trend is expected to continue in '08, as countries with a lot of capital at their disposal look to make investments in U.S. companies at good prices, says William Knapp, chief investment strategist at MainStay Investments.
"This is just the tip of the iceberg," Knapp noted in a recent report. "The headline grabbers will be the Middle East and Chinese buyers." The Middle East is awash in dollars from the high price of oil, and China is profiting mightily from exports to the USA.
Similarly, of the top 10 U.S. merger-and-acquisition deals announced from late July through early December, all involved a foreign acquirer buying a U.S. asset, according to Richard Peterson, director of capital markets at Thomson Financial.
•Global economies avoid U.S. flu. Global investors are still clinging to the notion that the U.S. housing crisis won't infect economies outside the USA, such as the fast-growing Asian economies, notes Larry Adams, U.S. chief investment strategist for Deutsche Bank Alex. Brown.
This concept is called "decoupling." If global growth holds up, it will boost profits of U.S. companies that do brisk business abroad. An economic analysis by Merrill Lynch forecasts a slight moderation in global growth to 5.6% next year, down from 6%, excluding the USA. Still, pessimism about the global economic outlook will put the decoupling thesis "to its sternest test," according to David Bowers, an independent consultant to Merrill Lynch.
•Low valuations give stocks room to grow. Stocks enter the year trading at less than 15 times their expected earnings for 2008. "That is historically low," says Georges Yared, chief investment strategist for Yared Investment Research.
Adds Jeffrey Kleintop, chief market strategist at LPL Financial Services: "Valuations are close to the bear market lows of October 2002." Stocks are also cheap relative to bonds, data supplied by Bespoke Investment Group show.
•Laggard stocks take flight. Often, the best stocks to buy are the ones that have been beaten down the most, says Bill Miller, a top mutual fund manager at Legg Mason.
"Usually, but not always, when you read about some industry or company having the worst time in years, you will find that buying when they're going through those difficulties proved to be quite profitable if your time horizon wasn't measured in days or months," Miller noted in a recent commentary.
Beaten-down financial stocks fit the bill. Since financials account for roughly 18% of the S&P 500, a rally in the sector will give the entire index a lift.
•Big stocks become leaders. In 2007, for the first time since 1998, large-company stocks posted bigger returns than small stocks. David Bianco, a strategist at UBS, predicts that trend will continue.
"We expect multinational blue chips to lead the market to record highs in '08," he says.
The reason: He says they have the ability to weather a U.S. slowdown because of their ability to tap growth opportunities outside the USA. If the U.S. dollar remains weak, these companies will also get a profit boost because their revenue earned abroad will translate into more dollars.
•Puny profits turn respectable. Not only will profits rise in '08 as the subprime mess fades, earnings may prove more resilient than people think, notes bull Edward Yardeni of Yardeni Research. Much of the earnings ugliness might "reverse by the second half of the year," Yardeni notes, adding that investors will start pricing in better future earnings in '09 and beyond.
•Election year keeps bullish bent. Bull markets tend to occur in the third and fourth years of presidential terms, with the election year enjoying the second-best stock performance of the four-year cycle, according to the Stock Trader's Almanac.
Why? The party in power "shamelessly attempts to massage the economy so voters will keep them in power," writes Jeffrey Hirsch, editor of the Almanac. The average gain in election years dating back to 1833: 6.7%.
Legislative gridlock on Capitol Hill is the most investor-friendly election outcome, especially if a Democrat captures the White House, notes Kleintop. The reason: If the congressional vote is split by party line, it will make it more difficult for the incoming Democratic administration to do away with or reduce the President Bush-created tax benefits to investors, such as low tax rates on capital gains and dividends.
•Eighth year lives up to hype. A market phenomenon known as the Decennial Cycle also points to an up year in '08. If you break up decades into 10 separate segments, it turns out that the eighth year of a decade is the second-best year, topped only by Year Five, according to the Stock Trader's Almanac.
Whether these bullish catalysts actually take root and translate into gains in '08 remain the biggest unknowns.
The success of the stock market next year is likely to depend largely on whether the economy is able to withstand downward pressure from the housing bust and avoid recession. In fact, 2008 will severely stress-test the consumer.
"It's crunch time for American consumers," because many are having a tough time keeping up with rising debt, says Peter Schiff, president of Euro Pacific Capital. Schiff, one of Wall Street's most pessimistic forecasters for '08, does not see a pretty outcome for consumers or stocks this year.
But if the aging bull — which is already longer than the average bull market of 56 months — can stay alive in '08, it will join a small, select group of just three bull markets since 1942 that posted gains in year No. 6.