Ironically, the markets have recovered a fair amount from their August lows, but few appear to be noticing, a situation we mentioned in our blog yesterday.  When this happens, it is known as “climbing a wall of worry.”  Indeed, the markets have climbed admirably in recent weeks in spite of predominantly soft economic data and skeptical media coverage. 


With everyone manically obsessed with what the Fed will or will not do early next week, we thought we’d take a short timeout to reflect on the year ahead.  I must confess to feeling a bit “different” writing about the year ahead when it’s only mid September.  Our industry is rarely focused beyond the next hour and one usually only sees these types of updates in early January.    But perhaps that’s just what we need. 

Here are some of the themes we see taking shape in the year ahead. 

Emphasize Organic Growers.  In a nutshell, growth through acquisition will be out (or at least less prevalent), while growth through innovation will be in.  We’re sticking with the theme that the best performing areas of the market will be from companies and industries whose growth is bred internally through innovation or globally through industrialization.  We’d put the technology, health care, and industrial sectors in this camp. 

Expect An Easy Fed.
  The Fed will begin to lower rates in the coming year, further establishing growth as the best performing style in 2008, just as the neutral policy initiated in 2007 has contributed to its outperformance so far this year.  While we would caution investors against trading around any single rate cut, the overall trend in Fed policy should serve as a tail wind longer term. We think the economic data — be it inflation, unemployment, and GDP growth – will be sufficiently tepid to allow the Fed some room to cut. 

Be careful with Housing and perhaps Real Estate Investment Trusts (REITs)
   It is unusual for specific subsectors of the market — especially those that have benefited from a bubble in investor affection — to consistently outperform for a period of more than five years.  Housing, though weaker for awhile now, clearly fits into this category as a likely laggard, and Real Estate Investment Trusts could follow suit as credit conditions soften.  At the same time, strong trends in international development could somewhat offset the impact of a slowing domestic economy on the REIT sector. 


Be Both Selective and Patient with Financials.
  The entities that financed a given spending bubble almost always suffer or at least trade sideways for a period of time when a bubble bursts.  Who might it be this time around?  Mortgage finance companies fit the bill as may some private equity and hedge funds.  But, it is also not yet entirely clear who may be left holding the bag given the increased packaging and worldwide syndication of loans in recent years.  Perhaps the bad loans have been spread far and wide, but perhaps not.   We believe it will pay dividends to be selective with one’s financial holdings and, in spite of “cheap” multiples, to keep one’s powder dry until more is known. 

Don’t Bet Against the Global Consumer.
  It used to be said that one should never “bet against the American consumer” but this view may need some adjusting.  While unemployment is sure to pick up due to a domestic economic slowdown, there will always be areas of employment growth, especially with trends in globalization.  It is important to recognize that the mid to high end consumer will always exist, but that their identity will shift from industry to industry and country to country as the economic tides change.  We would stick with consumer goods and services companies which have the ability to capture the hearts and minds of these consumers, wherever they are. 


Stay Warm by Sticking with Energy.
  In recent days, oil hit a price of $80 per barrel.  While it may be hard to get excited about buying a barrel of oil these days, we’d agree with economist Ed Yardeni, who believes that the cheapest oil these days may be found in energy stocks trading at below the market’s multiple.  Perhaps some caution is still warranted in the short run given the recent spike, but barring a global recession, we suspect energy stocks will help keep investor portfolios warm in the year ahead. 


Corrections in the market — like those we’ve seen this summer — sometimes offer clues on who might emerge as tomorrow’s leaders.  We believe investors might be well served by beginning to look past next week’s Fed announcement and towards the year ahead.