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Focus on the future

As investors search for a glimmer of hope, experts see reasons for optimism about the stock market in 2003.

By HELEN HUNTLEY, Times Staff Writer

© St. Petersburg Times
published January 5, 2003


The new year just has to be better for investors.

How could it get any worse? The stock market has been in reverse for three years. The safety conscious are lucky to get 3 percent on bank CDs. And money market funds pay almost nothing.

Discouraged investors have slashed their expectations. Since the end of 1999, the Standard & Poor's 500 Index, the broadest market indicator, has lost 40 percent of its value, taking it back to 1997 levels. Investors who once felt double-digit returns were their due would now happily settle for any return at all.

But amid the gloom, there are signs of hope.

While stocks obviously could go down for a fourth consecutive year, there are reasons to think 2003 could be better than the three years that preceded it. Here's why:

Gravity and history

Trees and markets don't grow to the sky, as investors painfully discovered. But they don't go down forever, either. This already has been the worst stretch for the stock market since 1939-41, and stocks haven't had four down years in a row since 1929-32. Yet this isn't the Great Depression. It isn't even a recession, although it feels like one to people who grew accustomed to robust growth.

"As bad as things were in the Depression, eventually the economy turned around," said Gerald Perritt, a Largo money manager and investment newsletter publisher. "As bad as the world strife was leading up to our entry in World War II, the market turned around."

History gives him and others confidence that this market eventually will turn around, too. Markets have a tendency to go to extremes before they change direction, but the longer the downturn hangs on, the more likely a rebound becomes.

"Just as five years of double digit returns probably didn't represent reality, four years of downturns probably don't either," said Clearwater financial planner Ray Ferrara of ProVise Management Group. "I have every reason to believe that the American free enterprise system will start to produce significant growth that will be reflected in long-term stock prices."

Stocks on sale?

Stocks are cheaper than they were three years ago, which makes them a good buy if you expect the economy and earnings to improve.

"Over time, the markets tend to follow corporate earnings," said Bill Sieffert, senior vice president at Northern Trust Bank of Florida in Tampa. "If you subscribe to the notion that the 12 interest rate decreases the Fed has made in the last 18 months or so will begin to pay off in terms of increased economic activity, presumably we're going to have some decent growth in corporate earnings. That should lift stock prices."

Stocks in the Standard & Poor's 500 Index were selling for about 31 times earnings at the market peak in 2000; now that's down to 29. Historically, 29 is not particularly cheap. Stocks were selling for a mere seven times earnings when the bull market began in August of 1982. Yet it is cheap enough to bring out some bargain hunters.

"If you look at reasonable earnings expectations for the S&P, the market is trading at reasonable valuation levels," Sieffert said. "There is at least an opportunity to gain some rewards for persevering in what has been a challenging market."

Thomspon/First Call projects a 14 percent increase in earnings for S&P companies in the year ahead. Because companies have cut expenses so vigorously, a pickup in sales in an improving economy should produce an even bigger increase in profits.

While the economy isn't exactly roaring back yet, it has shown enough life to give investors reason to feel encouraged.

"Though economic news continues to be uneven, there are some promising signs that are hard to dismiss," said Grady Garrett, a portfolio manager at LBS Capital Management in Clearwater. He said he is encouraged by productivity improvements and strong economic growth during the third quarter, even though growth is weaker this quarter. "Taken together, these indicators show the economy is on the path to recovery."

Negative overload

The numbers matter, but they aren't everything. Stock prices are determined not only by expectations for corporate earnings, but also by the price investors are willing to pay for a dollar of those earnings. That's where the emotions -- fear and greed -- come into play.

At market peaks, investors feel euphoric and chase rising stock prices. At bottoms they feel depressed and sit on their hands. Often they are wrong.

"A contrarian view provides hope that there is too much pessimism and stocks could show modest improvement," said Marge Schiller, a Sarasota financial planner.

Investor confidence is up from its October lows but still weak. In a survey conducted by UBS and the Gallup Organization last month, only 53 percent said they consider this a good time to invest in the financial markets, down from 73 percent two years ago. Their expectations for market returns have been cut in half. Instead of a 10 percent return on stocks over the coming year, they are looking for 5 percent.

The market's sour performance has had a devastating impact on confidence. Two-thirds of the older investors who have lost money in stocks say their lifestyles have been affected as a result, according to an AARP survey.

At the same time, investors have been disillusioned by corporate scandals. Enron Corp. executives set new standards for greed. Then WorldCom's deceit in accounting for $9-billion of expenditures forced the company into bankruptcy. On top of that, investigators revealed the duplicity of brokerage company analysts who publicly recommended stocks to investors while privately disparaging their prospects.

"We had an opportunity to really see the market rebound (this year) . . . but there was no confidence in earnings because of corporate fraud issues. That is what put us into the third year of declines," said C. Kim Goodwin, chief investment officer at State Street Global Advisors.

The problems prompted several reforms, including a new requirement for chief executives to personally attest to the accuracy of their companies' financial statements.

"Hopefully the accounting scandals are somewhat behind us because the accountants are now scared," said Steve Bolten, a finance professor at the University of South Florida in Tampa. He said investor discouragement is normal at the end of a down cycle.

"Investors became overly optimistic, foolishly optimistic, a couple of years ago," he said. 'They tend to get foolishly pessimistic on the other side as well."

Low interest rates

Ultimately many investors may turn back to stocks for lack of anywhere else to go.

The average yield on a one-year bank certificate of deposit is about 2 percent these days. The U.S. government just cut the rate on HH savings bonds from 4 to 1.5 percent. Those numbers mean investors who insist on safety are paying a tremendous price for it.

"Interest rates are so low that stock dividends may actually be greater than money market and short-term bond earnings," Sarasota planner Schiller said.

Many investors are holding cash they are afraid to invest in stocks and reluctant to invest at low savings rates.

"It's kind of like a buyers' strike," Largo money manger Perritt said. "People will come around; they just don't want to be the first ones through the door. They'll come to the party later on. The fact that there is tons of cash out there will give the bull market some legs once it starts."

He points out that individual investors are not the only ones holding cash.

"On balance, corporations have been very stingy about making capital expenditure commitments," Perritt said. "If you've got a bunch of cash in the bank and you're not going to spend it on capital equipment, what do you do with the money? It's earning 1 percent at the bank, and that's certainly going to drag down your overall return. So you look around for reasonably priced companies you might acquire. With stock prices coming down as much as they have, there are pockets out there where companies can look at possible acquisitions."

Of course, not all the signs are hopeful. The darkest clouds hanging over the market at the moment are the possibility of a relapse in the economic recovery, the potential for war with Iraq and the uncertainty of additional terrorist attacks. Only the likelihood of war with Iraq is reflected in current market prices.

"No one wants to see conflict and all the dislocation and human misery associated with that," said Sieffert at Northern Trust in Tampa. "It's not a foregone conclusion that markets would go down and stay down. They might go down initially, but if the war resolves itself pretty quickly, that may not be much of a drag on the markets. If it's something other than that, the markets might behave differently."

And if the economy were to falter, that could be even more problematic for the market than war. So while there are signs of hope for stocks, they are only signs, not sure things.

That means financial planners will still be preaching diversification in 2003. Because stocks might have a fourth losing year, most people should still have part of their money in bonds and cash. But because stocks might turn around -- and because bonds will suffer if interest rates creep back up -- most people should also have part of their money in stocks.

"Rational investment decisionmaking is based on good diversification and consistent pursuit of moderate growth -- without greed," planner Schiller said. "'Everything in moderation' works in investing as well as in weight control and New Year's resolutions."

-- Helen Huntley can be reached at huntley@sptimes.com or (727) 893-8230.

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