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25 Surprises for 2007

9. Corporate profits for 2007 end up virtually flat year over year, but the pattern is inconsistent. After rising 8% in first-quarter 2007, corporate profits are down 5% in second-quarter 2007, up by 2% in third-quarter 2007 and back down by 4% in fourth-quarter 2007.

10. Equity-market volatility, like credit spreads, rises exponentially. The S&P 500 routinely has 2% daily moves, acting more like a commodity than a stock index. Mutual fund and hedge fund redemptions rise dramatically.

11. Stocks begin 2007 the way they ended 2006 -- very strong -- and the S&P 500 temporarily breaches 1450 in February. But by the end of the second quarter, under the brunt of the mortgage implosion, stocks drop nearly 15% and remain relatively range-bound for the rest of the year. The S&P 500 ends the year at around 1250, dropping by about 11% in 2007.

Reflecting the deflationary threats, one of the best-performing groups of 2006, industrial materials, morphs into the worst-performing group in 2007. With credit spreads flying open, the junk-bond market records its worst performance in over two decades and substantially underperforms almost every asset class in 2007. Technology, pinched by an abrupt demand plunge in consumer electronics, a listless response to Microsoft's (MSFT) Vista and a drop in business spending, ends the year with a 20% decline in value.

12. Fidelity Management announces the introduction of its first dedicated short equity product. Alliance Capital follows with a similar product shortly thereafter.

13. With confidence in the markets and economies ebbing, merger-and-acquisition activity slows to a crawl by May. Several leading universities and endowments, which previously underwrote large private equity commitments, announce that they are dramatically reducing their exposure to that asset class.

As the capital markets falter, institutional funds committed to real estate are also reined in, initially leading to a marked slowdown in the recent appreciation in office building values. While broadening economic weakness leads to only a slight rise in office vacancy rates, as the year progresses vacancy rates deteriorate more noticeably. REIT shares get hit hard (and fall below net asset values) as the historic relationship between REIT dividend yields and the yield on the 10-year U.S. note mean regresses.

14. A well-known corporate raider finds himself with a concentrated portfolio of illiquid investments and suffers large losses. ESL's Ed Lampert cagily watches the early-year private-equity euphoria and does nothing, opting to shore up his liquidity. But as equity prices drop in the second half, he is joined by several previous corporate partners in making a large acquisition in the entertainment/media field by year-end.

15. America's growing dependency on convergence and connectivity (computers control power delivery, communications, aviation and financial services) becomes a battleground and launching pad for a series of cyberterrorism acts by a terrorist group in early 2007.

The first few virtual attacks are ignored and have no effect on the market or on the Internet. However, during a chaotic weeklong period after the July Fourth holiday, an attack renders the Internet partially ineffective, threatening to eradicate crucial information storage bases and to stop commerce and communication.

16. There are several political surprises in 2007. Most significant is that New York Sen. Hillary Clinton, citing personal issues, announces that she will not run for the Democratic presidential nomination in 2008 and that she will throw her support to former Vice President Al Gore's candidacy. Democratic hopefuls Barack Obama, John Kerry, Evan Bayh and Joe Biden do not pursue the nomination, leaving Senator John Edwards as Gore's only viable competition.

On the other side of the ledger, Newt Gingrich is an early aspirant to the Republican nomination and, surprisingly, is in a dead heat in early polls against the favorite, Sen. John McCain, with Mitt Romney and Condoleezza Rice far behind. Rudy Giuliani does not enter the race after a New York Times investigative report uncovers some questionable business dealings.

17. After New York Yankee baseball team owner George Steinbrenner falls seriously ill, SAC Capital Partners' legendary Steve Cohen acquires a majority control of the New York Yankees and, at year-end, retires from active management at his hedge fund.

18. Wal-Mart (WMT) fails to come out of its funk and reports five consecutive months of negative same-store sales. Overall retail spending follows the housing decline and briefly falls to levels that haven't been seen since the last recession as consumer confidence drops to lows not seen in more than 15 years. Purchases of discretionary items such as motorcycles, high-end kitchen appliances and jewelry suffer.

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