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Imagining What Could Go Right for Stocks

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Times Staff Writer

The big challenge for many investors in 2003 is imagining that, after three dismal years, anything can go right on Wall Street.

A second challenge may be intelligently evaluating the situation if and when things do appear to go right.

Why have any faith that the stock market can be a rewarding venue in the new year amid so much uncertainty about the economy, the Middle East, terrorism, oil, the dollar, etc.?

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Because the fact that so many people are skeptical of stocks’ prospects is an invitation for the market to do what it does best: shock the majority.

That assumes, of course, that the majority truly is skeptical. Bearish analysts say it isn’t so. They point to surveys of investor sentiment that show more bulls than bears.

For example, the Investors Intelligence weekly survey of investment newsletter writers last week showed 48.3% were bullish on stocks and 25.3% were bearish. The rest expect a modest market pullback in the near term.

“At a true market bottom, the sentiment figures would be just the opposite,” said Steven Hochberg, chief market analyst at Gainesville, Ga.-based Elliott Wave International, which believes that stocks’ slide is far from over.

Among individuals, however, some data tell a different story.

The American Assn. of Individual Investors regularly surveys members online about their attitude toward markets and their portfolio allocation. In the latest survey, stock bears outnumber bulls 37.8% to 32.4% (the rest are neutral).

What’s more, asked how their money was allocated among stocks, bonds and cash, respondents to the AAII’s December survey said they had 37% in cash, on average. That was down just slightly from 39% in October. Overall, cash levels reported by AAII members in recent months were the highest since late 1990 -- which marked the bottom of that year’s bear market.

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If you allow for the idea that a substantial number of professionals and individuals aren’t counting on much from the stock market this year, here are three potential positive surprises that could catch skeptics off guard:

* A normal “bear-market rally” amid a long-term decline. Some analysts who are bearish about stocks’ longer-term prospects are quite bullish about the shorter term. One of them is Tim Hayes, market strategist at Ned Davis Research in Nokomis, Fla.

Hayes believes that Wall Street remains mired in a “secular” bear market, meaning a long-lasting period of returns that will average out to be pretty poor. Nonetheless, he said, “I think what we saw in October was the start of a cyclical bull market.”

Historically, rallies of as much as 50% from bear-market lows have been typical before stocks begin to slide again, Hayes said.

Even in the Depression years of the 1930s, the market had some spectacular periods. As investors sensed that the economy was beginning to recover in 1933, the Dow Jones industrial average soared 67% after falling for four straight years.

More recently, the 1970s are remembered as a horrible period for the market, as inflation surged and many people questioned the long-term viability of the U.S. economy. The Dow ended 1979 at 839, no higher than it was at the end of 1970.

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But after diving in 1973 and 1974, the Dow rocketed 39% in 1975 and rose 17% in 1976.

After March 2000, when the current bear market began, the Dow’s best rally was a 24.6% gain in the fourth quarter of 2001.

Since the index hit a five-year low Oct. 9, it rose as much as 22.6% by Nov. 27. At Friday’s close of 8,601.69, the Dow was up 18% from Oct. 9.

The point is, even if key market indexes are no higher five years from today, in the interim some hot rallies are likely to ensue. They will test bearish investors’ resolve to stay out of the game. At the same time, investors who choose to play the rallies will have to decide whether to stay in for the long haul or peel off as share values advance.

The first trading day of this year brought a reminder of how rapidly the market can chalk up hefty gains. The Dow jumped 3.2% on Thursday. Add in the 2.2% annual dividend yield the Dow stocks pay at current levels, and the “total return” on the index would be about 5.4% for 2003 if it just finishes this year at Friday’s close.

Add two more days of 3.2% gains sometime this year, and the Dow’s return would be in double-digit territory for the first time since 1999 -- if, of course, the gains were able to stick.

* A new appreciation for technology stocks. Many investors who rode the tech-stock boom of the late 1990s -- and stayed in the stocks as they crashed over the last three years -- may swear they’ll never buy another one.

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But some analysts who are otherwise cautious about the market in 2003 believe the best returns may come from the battered tech sector.

“I see Nasdaq and the techs being the least vulnerable to a first-half slide. In fact, I see the possibility for a 50% gain in the Nasdaq by year-end 2003,” said Bernie Schaeffer, head of Schaeffer’s Investment Research in Cincinnati, who was the most accurate market forecaster in 2002 in Business Week magazine’s annual contest among experts.

“While many big-cap tech stocks are still aggressively valued, many of the small- and mid-cap techs have reached reasonable valuation levels,” Schaeffer said. “And sentiment on the techs has become outright negative, as evidenced by numerous bearish financial media articles on tech in recent weeks despite the fact that the Nasdaq has been the leader of the rally off the October lows.”

He favors such tech names as Western Digital, Ciena, Qualcomm and Amazon.com.

Ned Riley, investment strategist at money manager State Street Global Advisors in Boston, also believes technology is more likely to hold positive than negative surprises in 2003, after three years of heavy losses.

“I think it has to be” one of the best sectors to buy now, he said, because many investors continue to search for true long-term growth stories, and that still describes tech, in his view. Looking at U.S. industry sectors, Riley said, “tech still is our competitive advantage” over the rest of the world. “It’s not steel and it’s not autos.”

“I would be very surprised if the Dow and the Standard & Poor’s 500 beat the Nasdaq index in 2003,” he said.

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As with the market overall, however, a robust rally in tech stocks could force investors into tough decisions about whether to stay put or to take profits at some prudent level and head back to the sidelines.

* The U.S. and Iraq go to war, without severe market fallout. Many analysts believe that the fourth-quarter stock rally began to fade in late November because of rising war fears. In recent weeks, the dollar’s value has slumped and gold prices have hit five-year highs, also apparently reflecting investors’ concerns about a possible U.S.-Iraq conflict in 2003.

Caution would seem to be understandable in the face of war. But Edward Kerschner, chief global strategist at brokerage UBS Warburg in New York, notes that markets’ reactions to such crises usually depend more on the economic environment in which they occur than on the event itself.

“Confrontations, and even wars, in and of themselves are rarely sufficient to disrupt markets over the long term,” said Kerschner, who studied investor reactions during the Korean War, the Vietnam War, the Persian Gulf War and other conflicts.

If a war with Iraq caused the global economic recovery to be derailed, the effect on stock prices could be severe, Kerschner said. But he lists three reasons a conflict might not have broader economic repercussions.

First, he said, there is “little threat of escalation into a superpower conflict.”

Second, war with Iraq would be unlikely to trigger an oil boycott of the West by other Arab states, he said.

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Third, though oil prices could rise sharply at the outset of hostilities, “Much of world industry operates in an environment designed to be efficient with oil at $30 to $40 per barrel,” Kerschner said. Crude oil futures closed at $33.08 a barrel on Friday.

Are the optimists all wet? Maybe. Wall Street’s most vociferous bears say the bulls just don’t get it. The bears say stock valuations still are too high even after three years of declining prices. That’s a measure of how absurdly the market was valued at the 2000 peak, they say.

Elliott Wave’s Hochberg isn’t tempted by equities, despite the potential for positive surprises.

“Cash,” he says, “is not trash. Cash is every bit as valuable an asset choice now as equities were in the stock market mania.”

Tom Petruno can be reached at tom.petruno@latimes.com. For recent columns on the Web, go to: www.latimes.com/ petruno.

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