The US housing meltdown and credit crunch, which brought a swift end to an investment bonanza earlier this year, is likely to give Wall Street a stiff hangover during 2008, market strategists say.
A flurry of private-equity-fuelled buyouts and corporate take-overs helped propel the Dow Jones Industrial Average to an all-time record high of 14,164.53 points in early October, but the Dow has swooned since then as the housing downturn has worsened.
Investment strategists said the housing slump, now almost two years old, and a related credit squeeze that has triggered multibillion dollar losses at some of America's biggest financial firms, may temper stock market advances in the coming year.
"Growth has clearly slowed in the fourth quarter in the US," said Steve Bleiberg, president, Legg Mason Global Asset Allocation. Bleiberg said the over-riding concern for US investors in the coming 12 months would likely be the health of the credit markets and whether companies would be able to tap fresh capital.
Credit flows have tightened because big banks have lost billions of dollars in mortgage-related investments, which has forced them to curtail lending and triggered efforts by central banks to boost liquidity.
Overseas stock markets have also been singed by the pullback in US shares as foreign investors had also gorged themselves on US mortgage-backed securities during the housing market's boom years.
Some analysts believe the housing and credit woes could destabilise the wider US economy, or even trigger a recession, which would further depress Wall Street sentiment.
US investors are on tenterhooks awaiting to see if big retailers' earnings will be clipped over the crucial Christmas holiday shopping period by consumers reining in their spending. Strategists do not expect a mortgage rescue plan, essentially for Americans with patchy credit holding subprime home loans and backed by President George W. Bush, to significantly bolster Wall Street.
Some analysts believe the plan may just delay further property foreclosures. US economic momentum held up well for much of 2007, but the Federal Reserve trimmed its 2008 growth forecasts in late November to a range of 1.8-2.5 percent.
The central bank had previously predicted gross domestic product growth of up to 2.75 percent. As such many analysts are cautiously predicting single-digit gains for the Dow and the broader Standard and Poor's 500 index in 2008.
A recession, which is the worst-case scenario, would have a chilling effect on Wall Street. Markets usually take a number of years to recover from economic contractions, as was the case after the 2001 recession. While US investors might be exhibiting wariness, foreigners do not seem to have lost their appetite for US assets. A Singapore government-run investment fund, Temasek, is buying a 4.4-billion-dollar stake in Merrill Lynch, and the state-run Abu Dhabi Investment Authority has purchased a 7.5-billion-dollar stake in Citigroup.
Strategists said a weak dollar could tempt other "sovereign wealth funds" to snap up American investments which would inject new capital into US markets. Morgan Stanley announced ahead of the Christmas Day holiday that the China Investment Corporation (CIC) had obtained a five-billion-dollar stake in the firm.
The Dow is on course to post around an eight percent gain for 2007 while the S&P looks set to realise a rise of about five percent. The technology-rich Nasdaq index may yield a heftier 12 percent gain baring sharp market shifts.
Back-to-back interest rate cuts in September, October and December have helped shore up confidence, and some analysts say the Federal Reserve may have to slash borrowing costs further in 2008 to reassure nervous investors.
Analysts at Goldman Sachs foresee slower GDP growth and cooler profits on the horizon. "We have recently revised down our estimates for S&P 500 earnings per share in both 2007 and 2008, catalysed by the disappointments in the third quarter of 2007 and the expectation that sharp financial sector write-downs will continue in the fourth quarter of 2007," the Goldman analysts said in a briefing note.
For now, mega deals like the 32-billion-dollar take-over of Texas energy group TXU mounted by a private equity consortium, including Kohlberg Kravis Roberts, in early 2007 are unlikely to be repeated anytime soon.
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