As I've told Fools before, I believe there's real merit to combining top-down and bottom-up approaches to investing. The former will help you select the most attractive sectors for any given set of economic circumstances, while attention to individual companies allows you to maximize your performance within the hottest groups.
For now, let's focus on the top-down part of the investing process by looking at some of the key economic issues that we'll likely face as we try to pick our way through 2008. This area stands to be both good and bad, with energy, the falling dollar, and the oft-discussed housing market concerning economists, while strength in many other areas of the world and a relatively accommodating Federal Reserve just might help us to fend off a full-scale recession as the New Year progresses.
With that combination of forces in mind, let's look at some of the likely economic conditions that loom for '08:
Energy. Perhaps the most surprising happening of the past year was the effective doubling of crude oil prices, from approximately $50 a barrel to almost $100. The steady climb during the year can be tied to all sorts of phenomena, including rapidly growing demand among the developing nations, the dollar's decline, concern about instability in a number of producing nations, and the emerging role of traders in pricing the commodity.
It's perhaps surprising to note that prices escalated in 2007 without either a major upheaval in the producing world or damaging hurricanes plowing through the Gulf of Mexico. Oh, yes, Hugo Chavez continued to be a bad actor in Venezuela, internecine squabbling among tribes erupted in Nigeria, and Iraq still isn't back to normal as a major producing nation. But it's still not encouraging to contemplate the world of energy in the face of a major disturbance in, for instance, the Middle East.
In any event, those factors that pushed crude prices higher in 2007 are unlikely to abate, and so it's probable that we won't see a big price pullback during the year. As such, the integrated ExxonMobils
The dollar. With our economy beginning to sputter, the dollar has declined in relative value during each of the past two years. For instance, the currency has slid by about 11% against the euro this year and by 24% since the start of 2006. While that slide has helped U.S.-based exporting companies, it's also had a negative effect on the prices of a host of items -- certainly including energy. I wish I could make a case for a strong recovery in the dollar during the next 12 months, but I'm afraid I can't.
Housing. I've written frequently about our worsening housing morass, so I won't cover previously plowed ground here. Suffice it to say that with house prices sliding like children at recess and the pace of foreclosures almost certain to escalate in 2008, the sector's severe drag on the overall economy is also unlikely to wane.
The world economy. There once was a time when, if the U.S. sneezed, the rest of the world caught an economic cold. Thankfully, that's no longer the case. The economy of our planet has become sufficiently global that all manner of U.S. companies -- from Caterpillar
An accommodating Fed. As the U.S. economy has slowed, the Fed has shown a willingness to give it a boost. There are, of course, those who would argue that it's not the Fed's job to buoy the market, and cuts in the Fed funds rate certainly won't help to reverse the dollar's fall. But overall, it seems to me that the Fed acted sensibly and responsibly during 2007.
Conclusion. All this tells me that we're likely to face an especially challenging investment climate in 2008. For instance, energy, which performed well in 2007, may really test our mettle going forward. Beyond that, my advice to Fools for the New Year is one of caution and patience. Indeed, 2008 could be an ideal time to become a Peter Lynch look-alike. Invest in what you know and avoid jousting at windmills -- by chasing the homebuilders, for instance -- and your portfolio will likely be better off a year from now than it is today.
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Fool contributor David Lee Smith is busy working on his New Year's resolutions. He doesn't own shares in any of the companies mentioned but does welcome your comments. The Motley Fool's disclosure policy will move smoothly into 2008.