Reasons for a Sweeter Scenario in 2007

The case for gloom is, I admit, plenty strong.

Consumer spending, the big source of growth for the U.S. economy in this economic cycle, continues to slow, with growth dropping to 2.6% in the second quarter from 4.8% in the first quarter of 2006.

The real estate money machine that fueled that growth in consumer spending has run out of gas. New-home sales are falling -- down 4.3% in July -- and housing prices have flat-lined in many parts of the country. The housing market could get even cooler in 2007. On average, housing prices will climb just 0.43% in 2007, according to a survey of 48 economists by The Wall Street Journal. Factor in inflation -- projected at 2.7% in 2007 -- and real housing prices would fall by more than 2% in 2007.

Unit labor costs are soaring, up a revised 9% in the first quarter and 4.9% in the second quarter. That's certainly enough to put the inflation fighters at the Federal Reserve on high alert. A few more data points like that and the Federal Reserve could decide to start hiking interest rates again after the November elections. That would take another bite out of economic growth and stock prices.

Odds Rise for Recession

No wonder the gloom is getting awfully deep these days. On Sept. 8, for example, economists at HSBC Holdings warned that the U.S. could face a recession in 2007. The U.S. economy is likely to grow -- at best -- by just 1.9% next year, the economists said, down from their earlier forecast of 2.6% growth in 2007 and their projections of 3.5% growth in 2006.

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