Barron's roundtable is having trouble discerning a strong trend in 2007's economy and securities markets. The Goldman Sachs Group's (NYSE:GS) market analyst Abby Joseph Cohen, who accurately guessed that the S&P 500 would end 2006 at 1,400 -- it actually closed at 1,418 -- expects a 9% rise to 1,550 by the end of 2007. This precision masks significant confusion about the factors driving 2007's prospects.
I always enjoy reading Barron's annual roundtable, which pits savvy money managers against each other to predict what will happen to the economy and the market before they pick stocks for the coming year. This year's debate pits Fred Hickey, a New Hampshire newsletter writer, who thinks that a housing collapse and sluggish tech sales will lead to a big correction, against Cohen and others money managers -- who believe that global liquidity will bail us out.
Alan Abelson, Barron's editor, spent much of 2006 supporting the housing collapse school of thought. As I've posted here, here, and here, the housing collapse theory seemed persuasive. But I am now questioning the housing collapse argument because, although the economy has slowed down, it hasn't collapsed. There are at least three possible explanations:
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The housing collapse is too small a part of the overall economy to sink it;
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The collapse is taking longer than expected and it will play out in the future; or
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Global liquidity is offsetting the impact of the housing collapse.
At this point, I am leaning towards explanation three, with a dash of one and two thrown in for good measure.
The global liquidity comes from four primary sources:
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Oil profits. $500 billion in excess reserves controlled by OPEC resulting from high oil prices -- which its member countries cannot absorb at home -- and thus invest in stocks and bonds.
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Asian trade surpluses. $400 billion worth of excess reserves resulting from Asian trade surpluses, which countries such as China invest in U.S. government securities and others.
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Private-equity buyers, who were behind many of 2006's $3.8 trillion worth of mergers, and who took out $660 billion of stock from the public markets.
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Central banks around the world, which kept interest rates relatively low -- making it cheap for the private equity firms to finance these mergers, helped provide the capital to blow up the housing bubble, and are spurring stock margin debt -- currently at 2000's dot-com crash level of $270 billion.
What does all this mean for investors? My gut reaction is that Cohen will be right -- the market will be up in 2007. This despite the negative impact of a declining housing market, the likelihood of lower oil prices that will reduce OPEC's liquidity (while cutting a kind of tax on consumers), the possibility of rising bankruptcies -- resulting from a drop in asset values used as loan collateral, and geopolitical instability.
Peter Cohan is President of Peter S. Cohan & Associates, a management consulting and venture capital firm, a Professor of Management at Babson College, and editor of The Cohan Letter. He has no financial interest in Goldman Sachs.
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Reader Comments (Page 1 of 1)
1-15-2007 @ 10:47AM
Michael Schneider said...
The US is benefitting from very strong exports and great ag markets. Housing is being hit in some areas but agricultural areas and oil areas are making lots of money and there is still rebuilding in places like New Orleans.
You shouldn't underestimate housing though-- a correction as we have seen is great for the market, a true collapse would create recession- anything in between means a slowdown or soft landing unless there are dramatically lower energy prices which would give a lift to consumers.