2008 could see volatility of 2007

NEW YORK - The start of a new year often brings jokes about crystal balls, but with the arrival of 2008, many investors are ruefully saying they don't need fortunetelling gimmicks — they know that the problems that made 2007 painful and turbulent aren't going away with a change in the calendar.

The concerns about slowing economies, a weakening U.S. consumer and further tightness in the credit markets are likely to dog investors at least early on in 2008, observers say. While it is impossible to say with any certainty what will happen, few expect that the bumpy ride investors unwittingly began in mid-2007 will soon end.

A few Wall Street veterans agreed to weigh in with some of their predictions for 2008.

Q. Will the U.S. fall into recession?

A. "Right now, we've upped the odds," said Quincy Krosby, chief investment strategist at the Hartford, which oversees about $330 billion in assets. "We've always thought that the U.S. would be able to narrowly skirt a recession. For us the key is the employment data."

She contends the economy sits at a crossroads and whether a recession occurs will depend on whether unemployment remains low and whether the housing market can bottom out. She said the Federal Reserve will also need to continue to lower interest rates.

Q. Growth funds, which invest stocks likely to increase earnings and revenue but often don't pay big dividends like so-called value stocks, did well in 2007. Will that continue?

A. "We expect to see large cap growth outperform," said Krosby. "It's very difficult for investors to realize that a shift has gone on. That shift took place a number of months ago when we saw the baton go from small-cap to large-cap and now to large-cap growth. Large-caps come into their own during (economic) slowdowns."

Q. What will come of financial instruments such as mortgage-backed securities made infamous in 2007 when they hurt the performance of financial stock funds?

A. "You know Wall Street and the geniuses who created this — they're going to create something else in its stead," said Krosby. "The demand was fostered by a global demand for yield. This is why it popped up all over the world."

Funds — even normally safe money market funds — invested in products based on mortgages that were bundled and sold off to investors. But a weakening housing market made some of the assets underlying those investments shaky, as some homeowners found it impossible to make their mortgage payments.

Q. Funds that invested in areas such as emerging markets like China and other overseas economies were strong in 2007. How will such funds fare in 2008?

A. "If history repeats itself, then emerging market investors are due for big disappointment" because such spectacular growth is hard to sustain long-term, said Jack Ablin, chief investment officer at Harris Private Bank in Chicago, which oversees assets of more than $55 billion. "That's probably the most gnawing question keeping me awake at night."

Q. What kind of change might investors see in 2008 from 2007?

A. "I think that this global market isn't quite as disconnected as investors have hoped so I think that Europe weakens and that the European Central Bank will actually find themselves behind the eight ball and so the dollar will strengthen on the back of European rate cuts," said Ablin.

Q. Will sector-specific funds that showed strength in 2007 continue apace in 2008?

A. "The sectors that were the strongest in 2007 could be among the weakest in 2008 on the theory that we have recessionary tendencies in the world's largest economy and Europe and Japan aren't that far behind," said Joe Battipaglia, market strategist for the private client group at Stifel, Nicolaus & Co., which has $32 billion in client assets. He contends a slowdown in the U.S. economy would dampen demand for commodities such as oil and that a correction in emerging-market stock markets like China is due.

Q. Will large-cap funds continue to outrun small-cap funds?

A. "I think that will continue because these companies do tend to be more globally diversified and can be more of a safe-haven than small caps," said Battipaglia.