2007 outlook: Don't sweat housing

NEW YORK (CNNMoney.com) -- A top economist and market strategist at Citigroup both said Monday morning they did not think the housing slowdown is going to cause the economy to plunge into a recession or the stock market to fall into a tailspin in 2007.

Speaking at a breakfast for financial reporters at the company's headquarters in New York, Citigroup senior economist Steven Wieting said that concerns about a recession due to softness in the housing market are overdone.

An economist and market strategist from Citigroup don't think the housing slump will put a major dent into the economy or stock market in 2007.

In fact, Wieting said that if the housing market had not cooled this year, that would have presented a greater risk to the economy since it most likely would have led to increased inflation and probably more interest rate hikes from the Federal Reserve.

"Without the housing downturn, the economy would be overheating and there would be more inflation and tightening pressures," he said.

Wieting indicated that perhaps too much attention is being paid to the housing market and that there would need to be more than just a real estate slowdown to cause widespread pain to the consumer. He pointed out that consumers have so far withstood weakness in housing as well as a steady rise in the price of oil and gas over the past few years.

"There is this perception of an extremely vulnerable consumer that you've heard about for every day of your career and so have I," he said, in response to one reporter's question about consumer spending. "Consumer stability is nothing new."

Tobias Levkovich, the chief U.S. equity strategist for Citigroup, added that as long as the labor market remains healthy, consumer sentiment will likely remain relatively strong as well.

"Job growth should support continued spending growth," he said.

With this in mind, Levkovich said he conservatively expects the stock market to be up in the high-single digits to low double-digits in 2007. He has a year-end 2007 target for the S&P 500 of 1,500, about 8 percent higher than current levels.

Levkovich said one of the most encouraging signs for investors is that many companies are sitting on a large amount of cash. He pointed to figures that showed cash as a percent of total market capitalization for the S&P 500 is near a 20-year high.

As such, many companies are likely to increase stock buyback programs, pay down debt and boost their dividends in order to keep shareholders happy. "There is a lot of cash at companies that can be used to stabilize stock prices," he said.

Levkovich also said that large cap stocks should outperform small caps because he thinks the pace of earnings growth is expected to moderate to about 7 percent in 2007. Larger stocks tend to perform better when earnings growth is slowing. In addition, valuations for large caps are currently more attractive than smaller companies.

As for specific sectors, Levkovich said media stocks, technology stocks and retailers should outperform the market in 2007 while real estate, basic materials and utilities should lag.

Wieting added that investors in some housing-related stocks, particularly appliance and furniture companies, may not be factoring in the lag effect of this year's housing slump. He argues that weakness in housing this year could translate to soft sales of some big-ticket items that people normally would buy for their new houses next year.

So this could be the one consumer-oriented area that does not do well in 2007, both Wieting and Levkovich said, especially since many housing-related stocks have run up recently on hopes that the worst is over for the real estate market.

For example, shares of furniture and home furnishings maker Leggett & Platt (Charts) are up 5 percent in the past three months while appliance manufacturer Whirlpool (Charts) has gained more than 9 percent. Shares of carpet maker Mohawk Industries (Charts) are up 12 percent.

Shares of retailer Bed Bath & Beyond (Charts) and tool maker Black & Decker (Charts) have each gained nearly 20 percent in the past three months and furnishings retailer Pier 1 Imports (Charts) have shot up almost 25 percent.

Levkovich and Wieting also cautioned investors to be wary of emerging markets stocks, which have been extremely hot this year. Latin American stock mutual funds have soared 34 percent this year according to fund tracking firm Morningstar,while Asia-Pacific mutual funds (excluding Japan) are up 36 percent.

Levkovich called the recent performance of emerging markets stocks "frightening" and reminiscent of the U.S. tech bubble in the late 1990s.

And Wieting argued that even though the economies of many Latin American and Asian countries are likely to remain hot, this can't go on indefinitely, which could disappoint investors with increasingly high expectations.

"Improving fundamentals in emerging markets may be perfectly sustainable but not easily repeatable," he said.

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