Next year may be the last time many Americans utter the expression “safe as houses.” Growing anxiety that a housing market slowdown could hurt the overall economy is weighing on many investors’ and analysts’ minds, as illustrated by predictions that the U.S. Federal Reserve must cut interest rates to stimulate the economy.

At issue is the average American Joe or Jane, up to their eyeballs in mortgage debt, car loans and credit-card spending. If they slow their purchasing ways, it will hurt profits at consumer goods companies. The U.S. savings rate is below zero, and home foreclosures in October were up 42 per cent from a year earlier, according to RealtyTrac.

This can only mean one thing, says Mark Kiesel, an executive vice-president at Pacific Investment Management Co. in Newport Beach, Calif. “Companies make money when consumers spend. Consumers are going to pull back, and when they do, corporate profits are going to slow,” said Mr. Kiesel, who oversees $50-billion (U.S.) in corporate bonds at PIMCO, home of North America’s largest bond fund.

Mr. Kiesel disagrees with Federal Reserve chairman Ben Bernanke, who said last month that the pace of U.S. growth will pick up in 2007, and he mentioned inflation, often a sign of an overheating economy. Mr. Kiesel is not alone in his disagreement; according to economists contacted in a recent Bloomberg survey, the Fed will lower its target rate in the second quarter.

That helps explain why Mr. Kiesel is betting his billions on a weaker labour market and rising unemployment, forcing the Fed to cut its overnight target for loans between banks from 5.25 per cent to 4 per cent next year. That may in turn weaken the U.S. dollar, as investors seek higher yields elsewhere. The U.S. currency is on track for its fourth drop in five years against the euro and yen, as the U.S. trade deficit approaches a record.

As for which U.S. sectors he’s going to invest in for 2007, Mr. Kiesel follows some basic rules: “We invest in companies that have pricing power – are they able to raise prices?” As well, he will avoid U.S. companies with excess inventory and strong global competition. That means he’s eschewing house builders such as Toll Brothers Inc., DR Horton Inc. and Centex Corp. Nor does he like lumber companies because of their exposure to construction. Instead, he favours cable companies such as Comcast Corp., with strong assets in an industry with high barriers to entry.

Art Hogan, chief market strategist at Jeffries.&.Co., agrees there are some successes to be found in the U.S. stock market in 2007, but he suggests caution. “As far as U.S. equities go ..... one of the biggest discussions will be the pace of the economy,” Mr. Hogan said. “The biggest question is, do we have a hard or a soft landing? We know it’s slowing.”

He recommends that investors take advantage of mergers and acquisitions and seek out potential takeover targets. Last week, $45.4-billion (U.S.) in takeovers lifted the Standard & Poor’s 500 Index to a six-year closing high of 1414.76. Financial shares contributed to more than 40 per cent of the gain, the latest evidence of momentum in what has been a record year for M&A.

The software industry has a number of potential targets, Mr. Hogan said, including Business Objects, which he sees going to $45 (U.S.) in 12 months, from around $38 currently. He also likes gaming stocks such as Las Vegas Sands Corp., Isle of Capri Casinos Inc. and gaming equipment makers such as Scientific Games Corp.

Mr. Hogan also sees good plays in the energy sector, but rather than buying fully integrated oil companies (“they have a lot of moving parts, we never know how far out they’ve had production and price hedged out”) he likes service companies such as TransOcean Inc., McDermott International Inc. and Horizon Offshore Inc.

Overall, the U.S. stock market could prove challenging for investors, said Andrew Busch, a global foreign exchange strategist with BMO Capital Markets. “There will be a dark mood in the U.S. that will translate into a weaker dollar, economic growth will be slower, the mood of the nation will be darker ..... it will run into shaky territory in the middle of the second quarter,” he predicts.

There are signs to the contrary, however. U.S. unemployment is hovering close to the lowest rate since May 2001, while November’s average hourly earnings climbed the most in more than five years, and consumer stocks are currently doing well.

And even if you believe that a continued housing slowdown will hurt the U.S. economy, that doesn’t mean avoiding housing stocks altogether, said Michael Embler, chief investment officer at Franklin Mutual Advisers. Mr. Embler is a value investor. “We like to look at industries that are on their back,” he said. “We have been spending a fair amount of time in the home-building industry ..... They have rallied quite strongly off their bottoms, but we may get another opportunity there.”

Another theme in U.S. markets next year will be the weakening of the Republican Party, analysts say. With a Republican in the White House and Democrats holding the majority in both houses of Congress, there will be market implications, Mr. Busch noted. “Historically, with a split government and the backdrop of a Fed on hold, the larger cap stocks generally do well.”

Theresa Ebden is an associate producer for Report on Business Television.