New Year, Same Problem

A weakening dollar and record oil prices. No end to the housing slump in sight. Additional writedowns due to the subprime mortgage crisis. Concerns over higher inflation and slowing economic growth. The growing probability of a recession in the U.S.

Sound familiar? These are all issues that plagued markets during 2007, and while a new year will bring new resolutions for traders, it appears they will continue to wrestle with these same problems in 2008.

The major averages did finish 2007 in positive territory, but extreme volatility caused dramatic shifts during the later months, and indices finished well off their highs for the year.

The Dow Jones Industrial Average added 6.4% during the past 12 months, but was 6.3% off its all-time high set in October. Similarly, the S&P 500 ended 6.2% off its record high, and the Nasdaq Composite was 7.2% below its 2007 top.

"Stock market volatility, which had been noticeably absent the last several years, made its unwelcome return in 2007, and in a big way," says Steven Sheldon of SMS Capital Management. "Unfortunately, I do not see the volatility letting up much in 2008 with the economy transitioning into a lower gear."

Robert Pavlik, chief investment officer with Oaktree Asset Management, predicts that headwinds will continue to swirl after companies report their fourth-quarter earnings and provide their forecasts.

"Due to the cloudy nature of the economy and hesitancy of banks to lend, I expect earnings guidance to be more cautious, leading to a challenging first half of the year for the U.S. equity markets," says Pavlik.

Indeed, earnings are expected to kick off the year on the wrong foot when Alcoa (AA Quote) reports on Jan. 9. According to Thomson Financial, fourth-quarter earnings for S&P 500 companies should decline by 8.7%. That contrasts with a positive growth rate of 10.6% in the fourth quarter of 2006, coincidentally the last quarter of double-digit earnings growth.

Still, however ominous the year begins, earnings should get healthier as 2008 rolls on. Thomson expects that profits for the first quarter, which will start trickling in around April, should show a 5.8% growth rate.

In fact, it should get better with each succeeding quarter. While Thomson anticipates that earnings grew a meager 1.4% during the 2007 calendar year, expectations are for profits to rise 15.6% during 2008.