Amid Deep Skepticism, Some Market Pros Tout Stocks for ’03

“Better safe than sorry” has been the best investment strategy for three years running.

Now, Wall Street is desperately hoping that 2003 brings back the idea that taking risks can lead to better returns -- instead of more heartbreak.

While U.S. stocks suffered through their third straight annual loss in 2002, returns on high-quality bonds and on gold again shone brightly.

In part, bonds and gold have benefited because stocks have continued to stumble: Investors who have been afraid to own equities have opted for the perceived safety of Treasury securities and precious metals, as well as money market accounts.

But just as the stock market’s spectacular gains of the late 1990s came to an end, Wall Street’s optimists warn investors against assuming that the winning streak in bonds, gold and other alternative investments will go on forever, at stocks’ expense.

“If there’s going to be a surprise in the stock market, my sense is it’s more likely to be to the upside, if everyone is expecting the worst,” said Jack Ablin, who as chief investment officer at Harris Trust in Chicago helps oversee $40 billion.

“I think there’s a lot less risk in buying stocks now than in selling,” Ablin said.

The bullish case for shares is rooted in the expectation that the economy will continue to expand, albeit at a moderate pace; that corporate profits will continue to recover; and that stocks have fallen enough in the long bear market to make them attractive again relative to underlying earnings.

The investment policy committee at research firm Standard & Poor’s in New York in early December advised clients to boost stocks to 65% of their total portfolio, up from 60%. S&P; suggests that 15% of assets be held in bonds and 20% in cash.

Sam Stovall, S&P;’s chief investment strategist, said the firm projects that the blue-chip S&P; 500 index and the technology-dominated Nasdaq composite could rise about 15% this year as earnings rebound.

That would lift the S&P; from its year-end close of 879.82 to about 1,011, a level it last saw in June. A 15% gain in Nasdaq would drive that index from its year-end level of 1,335.51 to about 1,535, which also would be its highest since June.

A survey by Bloomberg News shows that the majority of investment strategists at major Wall Street brokerages also expect the market to rise this year. The bulls include Abby J. Cohen of Goldman, Sachs & Co., who believes that the S&P; index can surge about 30%.

But most of the strategists have been bullish, and wrong, since the bear market began in March 2000.

Bullishness may have become an occupational hazard for two of the biggest optimists last year: Tom Galvin was fired as strategist at Credit Suisse First Boston, and his counterpart at Lehman Bros., Jeff Applegate, also was canned.

Market pros who are bearish or at least cautious about stocks in 2003 primarily are worried that even though share prices have fallen sharply since 2000, they may not be low enough, relative to earnings, to attract enough investors.

Steve Galbraith, strategist at Morgan Stanley in New York, thinks that the S&P; index could rise as much as 19% this year, but he warns that “by most traditional valuation measures, stocks are not dirt-cheap yet.”

Depending on whose earnings estimate you use, the price-to-earnings ratio of the average blue chip stock is between 15 and 20 based on estimated 2003 operating profit.

The historical average P/E for the S&P; 500 is about 14.

“Only when compared with risk-free Treasury yields do stocks stack up as meaningfully undervalued,” Galbraith said.

But that may not be a minor point for institutional investors, some Wall Street bulls say.

Thanks to the bond market rally of the last three years, a buyer of 10-year Treasury notes today must settle for an annualized yield of 3.8% on those securities. On a five-year T-note, the annualized yield is 2.7%.

Money market funds, meanwhile, pay less than 1%.

Those returns wouldn’t come close to meeting the upper-single-digit returns many pension funds still are forecasting for their portfolios overall during the next 10 years or so. In theory, at least, that may leave such funds with little alternative but to take a chance on stocks, some experts say.

Though shellshocked individual investors may remain reluctant to jump back into the market, “it’s enough if we can just get more pension funds rebalancing” from bonds to stocks, Ablin said.

Still, the bulls acknowledge that the wild cards in all this are big ones: the possibility of a drawn-out war with Iraq, more terrorist attacks or some other unpredictable shock that would cause consumers and businesses to stop spending or investors to lose confidence.

If nothing else, the case for a market rebound in 2003 has history on its side: Four down years in a row is an extreme rarity. The last such period was 1929 to 1932 -- during the worst of the Great Depression.