Market Outlook: Subprime Seen Having Short-Term Impact on Stocks

Worries about subprime lending will continue to ripple through the stock market, but many analysts believe the impact on stocks will be shortlived and could be largely centered on the financials.

The bad news pouring out of the subprime lending industry has sparked concerns in global equities markets that the burden of bad debts will crimp lending, hurt the already weak U.S. real estate market and thereby slow down the U.S. economy and the consumer.

But analysts say those fears are largely overblown and that the economy is strong enough to withstand a hit from what is a small part of the market and that corporate earnings will remain relatively strong.

"I think the spillover will be largely in the financial space, in the banking space, and not necessarily the broad U.S. economy," Cassandra Toroian, CEO of Blue Rockefeller told CNBC.

Though analysts aren't expecting the subprime meltdown to have any lasting impact on the market, they are paying attention to signs that problems could be spreading.

"it's hard to say if subprime worries are overblown, but the fear is definitely real," Kevin Kruszenski, Head of Listed Trading at KeyBanc Capital Markets, told CNBC.com. 

"Everybody's trying to get their hands wrapped around this issue to see if it's going to spread to the overall broader mortgage market and possibly spread to the broader economy itself," said Robert Pavlik, Chief Investment Officer at Oaktree Asset Management. "If that's the case, it means liquidity issues because financial firms will pull back from lending to these mortgage companies. Tougher lending rates mean people pay higher rates for homes and have less discretionary income for other things like furniture and TVs."

More Jitters Expected

Steve Massocca, Co-CEO of Pacific Growth Equities, believes a liquidity crunch could cause more than subprime jitters.  "As liquidity moves out of the market, it will impact private equity buyouts done with liberal amounts of credit," said Massocca.  "You're going to see people require more equity on buyouts."

Financial stocks, which have been punished in recent weeks because of subprime worries, helped the market to turn around, when they rebounded late Wednesday after being the worst performing S&P 500 sector earlier in the session.

"I believe the financials have been the worst performing S&P sector in the last four weeks," said Brian Gendreau, Investment Strategist at ING Investment Management.  "So it could be that enough people out there are saying the economy is in pretty good shape, this selloff in financials is getting overdone, and it's a pretty good buying opportunity."

Before Wednesday's late-day turnaround, CNBC's Bob Pisani reported that traders had started to move money out of the financials in general, and that their focus was not just on subprime companies or brokers.  Wall Street expects earnings growth in the S&P Financials to increase 6% in 2007, and the overall S&P 500 to increase 8%.  Pisani says traders were starting to question the growth assumption in the financials, which might prompt changes in asset allocations in favor of other sectors.

"For the near term, I expect to see continued weakness in the financials," said Pavlik.  "I'd stick with high-quality, larger money center banks and avoid regional banks."

"Get a Lot Uglier"

" I think it's going to get a lot uglier," said Toroian.  "You're going to see major write downs in the valuations of the balance sheets of some of these companies. The real companies, like Countrywide, will do just fine in the long run, but some of these companies are really just air."

Some analysts believe the concerns about subprime problems are a temporary reflection of a larger issue.

"The bigger picture is that the market is sort of readjusting itself for slower growth in the economy and using subprime as an excuse to point the finger at something," said Pavlik.

"There is a legitimate fear that the Goldilocks scenario can't be achieved and a soft landing is at risk," said Hyman.  "We have to be aware of short-term factors such as subprime and technicals, but also longer-term concerns in the broaders economic risks."