2003 Could Be an Unusual Year

- Alan Lavine and Gail Liberman

However, U.S. bonds, the heroes of 2002, could be in for a rough ride. It's already been a difficult three years for stocks. The stock market lost -40 percent over that period, and interest rates hit a 40-year low. The economy grew at a snail's pace.

However, David Gibbon, bond portfolio manager with J.P. Morgan, London, says that in 2003, U.S. interest rates could rise. Although stocks may do better, U.S. bond prices could fall. The good news on the bond side: Gibbon believes that the European bond market should perform well.

European government bonds yield almost 1 percent more than U.S. bonds. The economic outlook for Europe shows no signs of improvement, which is good for European government bonds. The European Central Bank recently cut interest rates one-half-of-one percent. It is expected to cut rates in 2003 to kick-start the European economy. That coupled with a weak U.S. dollar spells higher bond prices abroad.

Gibbon's fund, American Century International Bond Fund, yields 4 percent. Sudi Mariappa, manager of the PIMCO Foreign Bond Fund, Stamford, Conn., agrees that European bonds will appreciate in value in 2003. He predicts that his fund could register a total return of at least 10 percent in 2003. Currently, Mariappa's fund yields 4 percent.

In a recently released report, Douglas M. Wilde, director of Merrill Lynch's investment policy group, New York, is optimistic about stocks in the2003. In 2001, he says, earnings per share dropped to $24.70 for companies in the S&P 500 stock market index. That represents a whopping 51 percent decline in earnings. But in ‘03, corporate earnings per share should hit $48--reflecting an increase of almost 100 percent.

"We expect annual (stock) market returns to be in the 7 to 8 percent range for the foreseeable future," Wilde said. "Merrill Lynch forecasts that inflation will remain modest, rising 1.7 percent in 2003. We believe the returns on the (stock) market will surpass those from bonds and cash investments."

What if we have a war with Iraq? The Merrill Lynch report shows that the stock market typically bounces back from a major crisis one year afterward. The report claims this happened after Pearl Harbor, the Korean War, the Cuban missile crisis, the Iraqi invasion of Kuwait, the beginning of the Gulf War, and the 1993 World Trade Center bombing. In each case, stocks rose 12 months after the crisis began.

Exception: The Sept. 11, 2001 destruction of the World Trade Center. In that case, stocks were down -13 percent one year afterward.

Some investment advisers say you should not get too excited about 2003. Edward Ladd, chairman of Standish Mellon Asset Management Group, Boston, says he is "modestly optimistic and impressed with the resiliency of the U.S. economy." Nevertheless, he expects the financial markets to be volatile. He also believes that the worldwide political risks are substantial.

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Alan Lavine and Gail Liberman are husband and wife columnist and authors of The Complete Idiot's Guide To Making Money With Mutual Funds, (Alpha Books).