Investors see growth slowing down in '07

The Fed is remaining vigilant about inflation.
NEW YORK (AP) -- Like a host weary of tiresome guests, Wall Street is hoping that some of the forces that made unwelcome appearances in 2006 will slink away and allow the party to continue into the new year, albeit in a quieter fashion.
A slumping housing market, inflation and low yields for long-term bonds could conspire to make it harder for Wall Street to find sizable gains in 2007 and extend the market's huge year-end rally. The question is whether any ramifications of an economic slowdown would be severe.
"I hope we haven't borrowed some of 2007's returns here in 2006," said Bob Doll, vice chairman and chief investment officer for global equities at BlackRock. "There is no way of knowing that but the market doesn't care about calendar pages."
But many on Wall Street expect the economy can execute a gradual slowdown without tipping into recession. History offers some hope. The final year before a presidential election has been positive for the Dow Jones industrial average for the past 68 years, according to the Stock Trader's Almanac.
Yield curve inversion
Bearish investors, pointing to a more ominous sign, note the inversion of the yield curve. The yield curve illustrates the difference in interest rates for short-term and long-term bonds. Ordinarily, it shows that as a bond's maturity increases, so does the interest rate. But the yield curve has spent the second half of 2006 inverted, meaning investors expect interest rates will be lower in the future than at present. Such a condition often portends economic recession.
"The inverted yield curve has been extremely predictive," said Hugh Moore, a partner at Guerite Advisors. By his estimation -- that an inversion occurs about a year before a market downturn -- investors should expect a recession to settle in by midsummer next year.
But while many others on Wall Street expect the economy can skirt recession, few predict the returns delivered in 2006 will continue apace. The double-digit increases in the major indexes have been impressive.
The Dow was propelled in the later part of 2006 by a drop in oil prices and robust growth in corporate profits. As it rose, the Dow pushed past the 12,000 mark for the first time after a meandering 7 1/2 year journey from 11,000 that saw an implosion of the dot-com bubble, recession and the terrorist attacks of Sept. 11, 2001.
"Certainly it's not going to be a bang-up year given the run-up we've seen in the last few months," said David Chalupnik, head of equities at First American Funds.
Debate continues over whether the performance of large-capitalization stocks next year will eclipse that of small cap stocks.
"When you see the large caps rally that is an indication that we're slowing down," Quincy Krosby, chief investment strategist at The Hartford, said of the overall economy.
Will it be successful?
Wall Street hopes to learn in 2007 whether the Federal Reserve's attempt to guide the economy to a soft landing will be successful. 2006 will go down as one of transition for the central bank; the Fed left rates unchanged at its last four meetings following a string of 17 straight increases that began in 2004.
The Fed hopes to avoid slowing the economy too quickly but remains vigilant about inflation. The rise in stocks in recent months in part telegraphs Wall Street's confidence in the central bank's ability to execute a soft landing, though the inversion of the yield curve has thrown some cold water on that sentiment.
Beyond inflation and interest rates, investors will keep close tabs on the housing market. A slowdown has touched off fears that some consumers will be reticent to continue spending as heavily.
Alan Levenson, chief economist at T. Rowe Price Associates Inc., contends a further adjustment is needed in the housing market but notes a correction in housing starts has already taken place. He believes consumers won't stop spending because the rise in housing values has been so sharp in recent years. Consumers will perhaps also keep spending because finding a job has become easier; unemployment recently hit a five-year low.