When the clock strikes midnight this New Year's Eve, many will be happy to give a goodbye kiss to one of the worst years in stock market history. The trouble is that the start of 2009 doesn't look as though it will deliver much relief.
As Wall Street investment strategists issue outlooks for next year, they are describing the early 2009 economy with such terms as "horrible," "awful" and "dismal," words you rarely see from individuals who tend to be optimists.
They see consumers in trouble with debt and job losses, businesses struggling to borrow money and hold onto customers, and cities, counties and states trying to do more with less as pressures on consumers and businesses reduce local tax revenue.
The strategists see an infection still permeating the financial system and the world's leaders still grasping for an effective solution.
Aware that every miserable cycle eventually ends, though, the strategists are embracing mid-2009 as a time that might bring some joy back to investing. The general outlook is that the economy will remain troubled throughout the year. Goldman Sachs economists, for example, think unemployment will reach 9 percent by the end of 2009. But they think a huge infrastructure-building program by the government will improve the economy in 2010.
Because stocks tend to respond in advance of an actual upturn in the economy, the assumption is that investors will start to take risks on stocks around the middle of 2009.
Goldman Sachs strategist David Kostin is estimating that the Standard & Poor's 500 index will rise 26 percent next year. Yet he and other strategists are advising investors to tread carefully.
"Our historical analysis suggests that it is better to stay defensive too long than rotate into cyclicals too early," Kostin said.
Cyclicals are stocks of companies that do best when the economy is on the upswing, such as retailers and heavy-equipment companies, with people eager to shop and businesses selling more products and buying materials and equipment.
A defensive posture might entail not being tempted by low prices to jump too aggressively into stocks.
Consumer spending makes up about 70 percent of the economy, and the U.S. consumer is important to economies throughout the world.
Consumers have lost enormous sums in retirement savings, and home prices are down 22 percent in major cities and likely to bottom at 33 percent, said Citigroup analyst Lewis Alexander. That will strip homeowners of $5 trillion, or 47 percent of U.S. disposable income, he said.
Meanwhile, credit card companies and banks are cutting back on lending. So the mixture of lost wealth, nervousness and tough lending standards will leave consumers saving more and spending less for an extended time, experts said. Businesses, too, will continue to cut back.
"It has become painfully clear that the ease of credit and liquidity it afforded provided the fuel for the financial, consumer and housing investing bubbles to develop over the past two decades," Merrill Lynch strategist Brian Belski said. "Consequently, supply in those areas now outstrips demand, and the necessary reduction in capacity will likely take several years to shrink."
Analysts such as Belski and Kostin emphasize investments in companies that make what people need regardless of economic conditions: consumer staples, such as toothpaste, and health care.
Experts say investors need to study companies in any sector for financial conditions that will allow them to weather a recession.
"Given the credit markets will likely remain tight for the foreseeable future, we believe those companies, industries and sectors that are able to self-fund themselves via high cash reserves and low leverage are best positioned going forward," Belski said.
Companies with financial strength and the ability to pay dividends are even better. And Kostin is advising investors to select large companies over small companies, and U.S. companies over Western European stocks.
Strategists are emphasizing care in bonds, too, suggesting high-quality general obligation municipal bonds and federally insured certificates of deposit, which typically pay higher interest rates than Treasury bonds.
High-yield bonds are paying tremendous yields, but the funds could incur large losses as bankruptcies increase.