Investing Opportunities for 2008

This being the first week in January, it's time for my annual conventional wisdom column. My theory is that conventional wisdom — the CW — is already baked into stock prices, so if you buck convention, and you're right, you can make a lot of money. The problem is that the conventional wisdom often is right, so you have to choose your shots carefully. And sometimes conventional wisdom can turn on a dime, as it did last week.

Still, it's always fun to do a little crystal ball gazing. How did I fare last year? I was right about the direction of the market — a good but not spectacular year, a little better than the CW was calling for. Best of all was my then-contrarian view that oil prices were headed higher, although I was way too cautious. Who would have dreamed back then of $100 oil? But the CW was that oil prices were in a long-term decline, so my strategy of buying oil stocks on weakness was a good one. I agreed with the CW that foreign markets offered attractive opportunities in 2007, but was flat wrong that developed Europe, Asia and Australia would outperform emerging markets. And I was wrong again that interest rates would rise, not that it mattered, since my recommendation was one- to three-year CDs.

This year, the conventional wisdom doesn't seem to have much conviction. Investors are still shaken by the real estate, mortgage and credit crises which dampened 2007 and continue to roil markets this year. Still, here's my stab at articulating the Conventional Wisdom for 2008, and my take on it.

The U.S. stock market will fall in the first half of 2008, recover in the second half, and end with modest gains. So far this prediction is on track, given last week's sharp declines. The prediction for a second-half recovery rests on the assumption the Federal Reserve rate cuts will continue, and their effects will be felt by midyear. I find this plausible. I've noticed a recent pattern where the Fed talks tough about inflation, hinting that rate cuts may be at an end, but then cuts in the face of economic weakness. I expect a steeper yield curve and higher liquidity, which should eventually give stocks a boost.

Oil and commodity prices will remain sky high. This is about as solid as the CW gets; hardly anyone is arguing to the contrary with oil now piercing the $100-a-barrel barrier. But oil simply cannot go up 60% a year indefinitely. I expect to be selling calls on my oil stocks in the near future, betting on at least a leveling off of prices, and I'll be doing the same for some of my holdings in commodity producers. They certainly gave my portfolio a boost last year, but expectations are so high that there's little room in their stock prices for disappointment.

Emerging markets have de-coupled from the U.S. and won't be affected much by a slowing U.S. economy. Last year I was bullish, though not bullish enough, on emerging markets. Most are now at record multiples compared to U.S. and European stocks. This disparity will not persist indefinitely. I agree that emerging markets have strong growth prospects, but I don't believe they're immune from economic weakness in the U.S. and Europe. Japan was one of the weakest markets last year, but now offers some compelling values, in my view. I'll go out on a limb and predict that developed markets will outperform most emerging markets.

Defensive sectors like consumer durables and health care will outperform growth sectors like technology and manufacturing. Given the growing economic malaise surfacing in consumer confidence polls, I agree that a defensive posture is in order, especially during the first half of the year. But as interest rate cuts begin to be felt, I expect technology and even battered financial shares will rebound by the end of the year and at some point, will offer compelling opportunities.

The real estate collapse will stabilize, and markets will begin to improve by the end of the year. I agree that prices won't fall forever, but many economists have been predicting a further 10% to 15% decline. I wouldn't begin to guess when that might happen and prices actually begin to recover. This is one area where the CW has been consistently too optimistic, and I'm not going to make any predictions — or investment decisions — until I see some hard evidence a recovery is underway.

If recent volatility continues (and the CW is it will) I expect plenty of opportunities to test the conventional wisdom and put contrarian strategies to work. With the Nasdaq just above 2500 last week, one has already appeared, since it dropped below the latest Common Sense buying threshold of 2575, which it last pierced in early December (see column of Dec. 4). If you missed that brief opportunity (as I did), this is your chance. For some specific stock suggestions, I encourage you to consult my column in the February issue of SmartMoney. But the important thing is to take advantage of corrections by buying something, even if it's an index fund.

So here's to 2008. It's certainly getting off to a fast start.