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The Wall Street Journal: A Happy New Year? It’s All Up to You.

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The Wall Street Journal: A Happy New Year? It’s All Up to You.

December 23, 2007

Forget China, corporate spending, oil prices and even the growing credit crisis. The key to whether the global economy holds up, and whether the stock market can rise in 2008, likely is in the hands of the U.S. consumer.

Meanwhile, for some brave investors, the anxiety about weak consumer spending and a possible recession in the U.S. may have already created some bargains.

Reining in Spending

As the housing market weakens, lending slows and energy prices remain high, investors are worried that U.S. consumers will put their wallets away and curb their spending on discretionary, or nonessential, items — perhaps finally trimming their debt and boosting savings in the process.

While that could be good for many individuals, it could be bad for the economy: Consumer spending accounts for more than two-thirds of U.S. economic activity, a figure that underscores its importance not just for the U.S., but also for big exporting countries like China, India and Germany.

Many stocks already have taken a beating in anticipation of this spending slowdown. The consumer discretionary segment of the Standard & Poor’s 500-stock index — a group that includes auto companies, restaurants and many retailers — has fallen 13% so far this year. Shares of retailer Nordstrom are down 26% and auto giant General Motors is down 13%.

By comparison, companies selling “consumer staples,” or items that aren’t usually impacted very much by a downturn, such as soap, toothpaste and detergent, have risen 13% in 2007. Colgate-Palmolive and Procter & Gamble are up 21% and 15%, respectively.

Last week, the Dow Jones Industrial Average rose 0.8% and the Nasdaq Composite Index gained 2.1%. That brought their gains for the year to 7.9% and 11.5%, respectively, while the S&P 500 is up 4.7%.

The shift away from consumer discretionary stocks could continue amid signs of an economic slowdown, some say.

Jack Ablin, chief investment officer at Harris Private Bank in Chicago, says: “I continue to recommend that investors [buy] consumer staples and [short] consumer discretionary shares….Staples have both valuation and momentum, while discretionary stocks are overvalued and losing ground.”

Some say slowing consumer spending might be healthy, at least for the long term, if unemployment stays low and individuals finally can build savings and cut debt. But it also will put a crimp in the shares of a range of companies catering to consumers. Indeed, some analysts expect this holiday shopping season to be the most disappointing in several years.

Risk in Auto Shares

Some analysts say investors should be especially wary of auto shares.

“We believe that consumer spending will continue to weaken and that recession concerns are not yet over,” Brian Johnson, a Lehman Brothers auto analyst, declared in a recent report. “We expect auto sales to fall further in 2008 and believe that auto stocks are not likely to be supported at current levels.”

Mr. Johnson recently reduced his ratings on a range of auto-related companies, such as Tenneco and American Axle & Manufacturing Holdings.

Bank of America is worried about shares of Mohawk Industries, a flooring company that could see problems if housing weakens further.

But looking on the bright side, if a recession is averted, consumer stocks could lead the market back. So investors should search for reasonably priced consumer stocks, especially those that might hold up well in any slowdown.

Personal consumption climbed by 1.1% in November compared to the month before, the Commerce Department said Friday, the highest rate of increase since May 2004. October’s spending tally was revised upward. These are signs that perhaps there won’t be much of a hiatus in spending.

Economic “growth is not falling off a cliff,” says the investment team at Bridgewater Associates.

Shares of consumer discretionary companies could do much better in the second half of next year, argues Ed Hyman, chief economist of ISI Group, in part because their revenue and earnings will be compared with the poor performance of this year’s second half.

Stocks to Buy Now

One stock that some analysts are getting more excited about: Hasbro. Shares of the big toy maker are down about 5% this year, but almost 4% of analysts covering Hasbro have raised their estimates for this year’s earnings in the last 12 weeks, and almost 5% of analysts have upped their expectations for next year in the last 12 weeks, a positive sign.

Arby’s fast-food chain is inexpensive compared with its rivals and could hold up well in a downturn as patrons shun other higher-cost restaurants.

Among consumer staples, Bank of America recommends Anheuser-Busch, which it says is trading at an inexpensive price, despite an 8.6% advance this year. The company is expected to refocus on marketing its key beer brand, Budweiser.

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