Just about a year ago (Oct. 13, 2006) we published a short article called 'Seven For '07,' a follow-up the 'Six for '06' published a year earlier.  Well, this is a good time to look back and see how the predictions panned out.  Yes, I know that 2007 is not over, but it has been a little over a year since it was published.  Let's first start with the macro overview at the start of the piece:

'As I peer into my crystal ball into 2007, we must admit to seeing a fair amount of cloudiness. I think that overall economic growth will be significantly slower than in 2006, but this softness will fall short of falling into a recession.  The yield curve is inverted, and historically that has presaged a slowing in the economy. The key culprit in the growth slowdown is likely to be the housing market.  The bubble is clearly bursting, but the housing market tends to move in slow motion.  With no upward movement in housing prices, indeed a likely decline, people will be less likely to take money out of their houses, and this will cause some slowdown in consumer spending, which makes up more than two thirds of the economy. 

'Offsetting that is a boost from lower energy prices, which allows consumers to spend more on other items.  I don't think we are likely to see a collapse of energy prices, but as we move forward, the high prices of earlier this year will be the base for year-over-year comparisons.  The prices are still high enough that it makes sense for oil firms to do everything they can to find more oil, so there are still very strong opportunities in the Energy sector, especially given the very compelling valuations in the sector.  

'The inflation picture should improve.  This should allow real wage growth to finally increase a bit, so the picture is of softness in consumer spending, not a collapse.  Worldwide growth should continue to be strong; I see no significant slowdown in India and China, while Japan and Europe might pick up a little bit.  The overall valuation of the market is quite attractive, particularly relative to bonds, and there is virtually no chance the Fed will be raising short term rates anytime soon.  While the rate of earnings growth may slow, it is likely to stay positive, and we might get some P/E expansion.  This would lead to a good but not great year for the market over all, with the S&P 500 rising in the mid to high single digits.'

All in all, I would call that a reasonably good forecast.  I was not as bullish as I should have been on energy prices, but was still very much of a bull on energy stocks.  The economy has slowed but not stopped, with housing being the key factor in the slowdown.  The consumer has slowed a bit, but consumer spending has clearly not collapsed.  Worldwide growth has indeed been strong, led by China and India.  Rising real wages were more of the reason than falling energy prices. 

The Fed did not raise rates in 2007 (this forecast was made shortly after the Fed started to go on hold after a series of 17 straight rate hikes), and eventually cut rates last meeting.  Earnings growth has slowed but remained positive.  I was a little conservative on my prediction for the S&P 500, which is up 12.85% over the last 52 weeks, but mid-to-high single-digits was not a terrible call.

'OK, now let's look at the specific picks.  They were Joy Global (JOYG), Interdigital (IDCC), Schering Plough (SGP), Valero (VLO), CSX Corp (CSX), Diamond Offshore (DO), and United Dominion Realty (UDR).  Of the seven, five were winners and two were losers.  While over the last 52 weeks the S&P is up 12.85%, an equally weighted portfolio of these seven names would have returned 26.13%. 

The worst performer was IDCC, where some unfavorable royalty arbitration awards, delay in the roll out of 3G wireless in China and some management turmoil all weighed on performance.  The stock is down 36.07%.  It still has a great balance sheet and holds the patents on some key wireless products.  We still like the stock at these levels, but it is not one of our top picks. 

The other loser was UDR, down 25.40%.  We thought that the softness in housing would lead to fewer people buying houses and more people renting apartments.  For a major residential landlord, this should have been good news.  Clearly we underestimated the effects of unsold condos going back onto the rental market, increasing supply.  Rents have been up more than inflation, but not nearly as much as we expected; meanwhile the valuation that the market puts on anything associated with housing is clearly less today than it was a year ago.  The stock still looks attractive to us and is a good substitute for bonds with a dividend yield of 5.5%.

We were right to overweight the Energy area, with 2 of the seven picks (28.6% of the portfolio vs. 11.3% of the S&P).  Diamond Offshore was the biggest winner, up 72.05%.  We still love this stock.  The world desperately needs to find and develop more large oil fields, and the most likely place they will be found is in deep water.  The world's supply of rigs capable of doing this is largely in the hands of tow firms DO and Transocean Offshore (RIG).  We like them both, and at this point we would slightly favor RIG due to a very good merger with Global Santa Fe and slightly lower valuation. 

Valero was the second energy pick.  Refining margins were exceptionally strong early in the year but have since faded as crude prices have skyrocketed but gasoline prices have been stagnant or down since the spring.  Long-term, we think it's a good stock to own, but is no longer one of our top picks in the sector.  Joy Global was up 28.94.  It was the only holdover from the 'Six for '06' list.  It is doubtful that it will make it to the 'Eight for '08' list, but still worth holding on to, or even adding to on weakness, but it is no longer a top pick. 

CSX did well as well, up 29.14%.  Long-term, we love the rails as it is much more energy efficient to move goods by rail than by truck, and we think the group will pick up significant market share.  However, it is vulnerable to an economic slowdown and its fuel costs are headed up.  We think it is a solid long-term holding, but not exciting at these levels.

Finally Schering Plough was up 41.34% has the best profile of new drugs coming onstream/lack of patent expirations of any of the major pharma firms, which should lead to the best earnings growth of the group.  The valuation is less compelling than a year ago, but it still worth accumulating at these levels.

We will be publishing an 'Eight for '08' list within the next few weeks.