In 2007 cash (in the form of holdings of short-term Treasuries or money market funds) outperformed the stock market in the US. The year ended with a bearish note as all major indices down on Monday. 

The broad index of the US stock market, the S&P500, ended the year up a mediocre 3.5%: that is less than the inflation rate for the year (that was above 4%) and that is less than holding a money market fund or a basket of short-term US Treasuries.

And the year ended with a slew of poor macro news with more to come: new home sales plunged while the marginal increase on existing home sales was associated with falling prices of home (a direct signal that homes sales are going up only because the increased excess supply of homes is driving prices lower); defaults on insured mortgages were up a whopping 35%.

Also a report suggested that Q4 earnings will be very poor. Indeed as reported by Reuters:

Projections for S&P 500 companies' fourth-quarter earnings swung to a 6.1 percent drop on Monday from an 11.5 percent rise on October 1, in the biggest quarterly move since Reuters Estimates started compiling analysts' forecasts in 1999. The sharp decline comes as financial write-downs and an economic slowdown take their toll on corporate results, pushing down forecasts for the fourth quarter.

First- and second-quarter estimates have also fallen significantly. Analysts now expect first- and second-quarter earnings to rise just 5.1 percent and 5 percent, respectively, according to Ashwani Kaul, senior market analyst at Reuters Estimates. That's down from an October 1 expectation of 11.4 percent earnings growth for the first quarter and 9.4 percent growth in the second. "The surge in analysts' conservatism is primarily the result of the subprime crisis in the U.S. and globally and its impact on the write-downs in the financial sector," said Ned Riley, chief investment officer at Riley Asset Management.

The financial sector, which has been battered by losses tied to subprime mortgages, is expected to see year-over-year earnings down 62 percent in the fourth quarter. "Forecasters are also becoming more sensitive to the possibility of recession in the United States, and those macro forces will exert huge influence over consumer spending in the United States as well as globally," Riley said.

There were more profit warnings than positive pre-announcement statements in December, according to Reuters Estimates. Of the companies that gave forward-looking guidance statements, 193 companies gave negative guidance compared with 161 that gave positive guidance.

So Q4 was most likely very mediocre for earnings;  while Q1-Q2 do not look much better as even the modest earning expectations of analysts may be revised downward as poor macro and corporate news batter earnings. But compared to 2007, 2008 may be real bearish for stocks: in a typical US recession the S&P 500 falls by an average of 28% in nominal terms and 21% in real terms.

No wonder as recessions are associated with sharp drops - of the order of 15-20% - in earnings. Many sectors earnings have already taken a major beating in 2007: financials, home builders, consumer discretionary, retailers. The next shoe to drop will be all the other cyclical sectors of the economy that will seriously suffer from the forthcoming recession. So while 2007 was lousy for the US market 2008 may end up being much worse.  Even more than in 2007, in 2008 cash will be king.

Happy New Year to all of you!

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