Investors Face Tough Decision on Stock Rally

With one month left in 2003, many stock investors face a tough decision: Is it smarter to cash in some of this year’s hefty returns -- or put more money into the market, betting that the rally will extend well into 2004?

It has been a long time since most people had any equity profits to protect. This calendar year is on track to be the first positive one for Wall Street since 1999.

Most major market indexes are up 20% to 40% since Jan. 1. The average U.S. diversified stock fund is up 27.5%, according to Morningstar Inc.

But as the gains have mounted, many investors may be focusing on potential threats to their winnings rather than on the idea that a new bull market may be underway.

Alan Skrainka, chief market strategist at brokerage Edward Jones in St. Louis, says that as he travels around the country meeting with individual investors, the accent is on the negative in the questions he gets.

Many people, he said, fear that China and India will take away all of America’s best jobs. Others worry about the ballooning federal budget deficit.

Investors’ reluctance to sound too upbeat, despite the stock market’s unequivocally bullish tone this year, reflects the fear induced by the deep 2000-02 bear market and the painful comeuppance for those who bought into the “new economy” talk of the late 1990s, Skrainka and other analysts say.

To express excitement about the economy or stocks today, “You sound like you’re naive -- like you haven’t learned anything,” Skrainka said.

Yet the evidence pointing to a robust economic recovery has become irrefutable in recent weeks, Wall Street optimists say.

Last week the government revised its estimate of real gross domestic product growth in the third quarter to an annualized rate of 8.2% -- the fastest pace in nearly 20 years.

What’s more, the report showed a big pickup in business spending, suggesting that more companies are growing confident that the recovery will be sustained into 2004 and perhaps beyond.

More recent economic data also have been stronger than expected. Nine of 12 major economic reports released in the week ended Wednesday beat analysts’ expectations, said Robert Podorefsky, interest rate strategist at FleetBoston Financial Corp. in Boston.

Faith in the economic outlook is what underpins the views of market pros who say it’s too early to bail out of stocks just nine months into the current rally. A stronger global economy in 2004 should mean another boost to corporate earnings, which already are up sharply this year, they say.

Many analysts have continued to underestimate the pace of the economy and earnings gains this year, and they may be doing the same in their estimates for 2004, optimists contend. If true, that could leave more potential for stock prices to pleasantly surprise investors next year.

“I can’t recall since maybe 1982 the gap between economic opinions and economic reality being so wide,” Skrainka said.

Only in the last month have more individual investors begun to adopt a less dire outlook for the economy and the stock market, according to a survey reported last week by brokerage UBS and the Gallup Organization.

The monthly UBS survey showed that 60% of investors now consider the economy to be in a sustained expansion or recovery, up from 48% in October.

An overall index of investor optimism that is calculated based on the survey responses jumped to a 20-month high of 93 last month from 69 in October. Still, the index is far below its levels of early 2000, when it topped 160.

If many investors still are talking cautiously about the stock market, the action in share prices day to day indicates that there is widespread reluctance to head for the exits.

Major market indexes have pulled back three times since mid-September. Each time there has been only a modest decline in the average stock before buyers have jumped back in and pushed prices up again.

For example, from Nov. 3 to Nov. 20 the Standard & Poor’s 500 index slipped 2.4%. By Friday it was back to 1,058.20 -- less than one point below the Nov. 3 close, which was a 52-week high.

That kind of quick-repair action suggests that the rally has further to run, said Doug Sandler, chief equity strategist at Wachovia Securities in Richmond, Va.

“It’s a sign that there are a lot of people on the sidelines” who are eager to get into the market, he said.

The breadth of the market’s advance this year -- meaning the sheer number of stocks that have risen in the rally -- also has impressed many pros.

About 85% of New York Stock Exchange issues are trading above their prices of a year ago, said Edward Yardeni, chief investment strategist at Prudential Equity Group in New York. That is the highest percentage since 1998, when the last bull market was going strong.

A broad market advance indicates that investors are finding many different stocks appealing. This year has seen aggressive buying in such disparate sectors as banking, gold mining, real estate investment trusts and technology.

Even during the last month, when the rally weakened somewhat, the market’s breadth remained healthy. Within the S&P; 500 index, 79% of stock industry groups rose from Oct. 28 to Friday, on average, while just 21% lost ground.

The industry-group gains were even more pronounced in indexes of small and mid-sized stocks, according to Standard & Poor’s data. Those stocks have led this year’s rally, which is typical coming out of a bear market and a weak economy, analysts note.

Yet the huge gains this year in many stocks that were deeply depressed by late 2002 have frustrated some investors.

Bill D’Alonzo, a veteran stock fund manager and chief investment officer of Friess Associates Inc. in Delaware, which manages the Brandywine mutual funds, said there had been a “rubbish rally” in the market -- “where stocks with no earnings, and stocks with the highest price-to-earnings ratios, have been the better performers.”

That has the earmarks of a “mini speculative bubble,” he said.

Nonetheless, D’Alonzo said, his firm’s focus on higher-quality stocks hasn’t left it sitting out the market rebound. The company’s flagship Brandywine Fund is up 30.6% this year.

“We’re finding plenty of good, solid stocks with good, solid fundamentals selling at reasonable price-to-earnings ratios,” he said. The firm’s average stock is priced at 17 times next year’s estimated earnings per share, he said.

Many market pros say they don’t minimize what could go wrong for stocks. They concede that geopolitical shocks are an ever-present danger, but they also say there’s no way to plan for those.

As for interest rates, Federal Reserve officials have continued to stress they’re in no hurry to tighten credit, FleetBoston’s Podorefsky noted. “The Fed keeps talking about doing nothing,” he said. That is providing support for the economy and the stock market.

If share prices should take a big hit soon, the important question would be whether there’s any significant change in the global economy’s momentum, Wall Street bulls say. If the answer is no, then any sell-off should be short-lived -- and a good opportunity to buy, they say.