Effect of Stocks’ Big Year May Not Stop at Wall St.

The U.S. stock market scored a huge comeback in 2003, ending the worst decline in at least a generation and lifting well-known indexes 25% to 50%.

The significance of the turnaround, after three years of heavy losses, may go beyond the gains investors will tally on their brokerage and mutual fund statements.

By avoiding a fourth consecutive annual decline, the nation escaped what might have been psychologically distressing comparisons to the last time such a streak occurred: the period of 1929 to 1932, the first phase of the Great Depression.

That fear had permeated Wall Street at the start of the year, as stocks tumbled in January and February.

What’s more, the market recovery that began in spring -- improbably, in the face of the Iraq war and a deflation scare -- may have been crucial in stoking expectations that economic growth soon would accelerate, many experts say.

“I don’t think the economy would have done nearly as well as it did” without the market’s comeback, said Sung Won Sohn, chief economist at Wells Fargo & Co. in Minneapolis. “Now, they’re feeding on each other: The economy is helping stocks and stocks are helping the economy.”

As the value of U.S. shares has risen by more than $3 trillion since mid-March, to about $13 trillion, it has underpinned consumer and business confidence and spending, Sohn said.

For the blue-chip Dow Jones industrial average, which ended the year Wednesday at a 21-month high of 10,453.92, the gain in 2003 came to 2,112 points, or 25.3% -- its biggest calendar year advance since 1996.

The technology-dominated Nasdaq composite index, the preeminent symbol of the late- 1990s market mania and of the crash that followed, rocketed 50% for the year to close Wednesday at 2,003.37. It remains 60% below its record high in 2000.

The rally was a worldwide affair. By some measures, global markets as a whole in 2003 made their sharpest jump in 17 years. Mexico’s main stock index soared 44%, Germany’s rose 37% and Japan’s was up nearly 25%.

Market bulls say the revival is foreshadowing that the global economy is headed for better times, despite continuing worries about terrorism, trade battles, energy prices and other concerns. Historically, stocks often have presaged the economic trend because investors are continually looking to the future and new opportunities.

“We are experiencing the early stages of a global boom,” declares Edward Yardeni, chief investment strategist at Prudential Equity Group in New York.

Some analysts also say the market’s snapback in 2003 reflected pent-up demand for stocks that had been suppressed in 2002 by that year’s wave of corporate scandals and by the approach of the Iraq conflict, even as the U.S. economy continued to grow.

“If you took away the exogenous shocks and let the fundamentals play out, I would have expected a positive year in 2002,” said Philip Orlando, a money manager at Federated Investors Inc. in New York.

In recent months the market has largely ignored the latest Wall Street scandal, which involves alleged trading abuses at some mutual fund companies.

But some market pros contend that investors who have been eager to buy shares again are ignoring fundamental problems in the U.S. economy that could result in another recession sooner than later, devastating many companies.

David Tice, head of Dallas-based investment firm David W. Tice & Associates and a pessimist on stocks since the mid- 1990s, insists that the market decline that began in 2000 has been interrupted but not ended.

The economy, he said, is burdened by record debt loads and is only being propped up by the Federal Reserve’s maintenance of short-term interest rates at 45-year lows.

Tice believes that the stock market has again become a “bubble” -- meaning that share prices have been grossly inflated -- and that the implications for the economy are worse than in the late 1990s because residential housing prices have followed a similar path since 2000, in his view.

Both stocks and housing are certain to deflate with dire consequences, he said.

“The Fed is trying to perpetuate the bubble; they don’t want it to go down,” Tice said. “But I don’t think they can keep it going another year. You can’t continue to borrow your way to prosperity.”

Tice’s views don’t resonate with most market veterans.

William Nygren, a partner at money manager Harris Associates in Chicago, said he believed that investors returned to stocks in 2003 because they saw that share prices, which had plunged 35% to 80% from their 2000 peaks based on major market indexes, didn’t reflect the true long-term prospects of many companies.

The optimists have been proved correct, he said, as corporate earnings rose to record levels in the second half of last year.

It’s also important to note that stock prices, relative to underlying earnings, for the most part aren’t near the levels of 2000, Nygren said.

A classic yardstick of stock valuation is the price-to-earnings ratio, the stock price divided by annual earnings per share. For the blue-chip Standard & Poor’s 500 index, the P/E ratio in March 2000 was 29 based on so-called operating earnings per share, meaning corporate results excluding one-time gains or write-offs.

By contrast, at its 2003 closing level the S&P; index P/E is about 19 based on S&P;’s estimate of 2004 operating earnings for the index.

A lower P/E, in theory at least, means there is less risk in stocks.

“People who think this is a bubble like 2000 have forgotten what 2000 was like,” Nygren said. “The market looks reasonable to us.”

Some Wall Street pessimists cite the hot rally in many technology stocks this year as a sure sign of absurdly high share prices. But the numbers can be misleading.

Consider computer networking giant Cisco Systems Inc. Its shares zoomed 85% in 2003, from $13.10 at the start of the year to $24.23 as of Wednesday. Yet the stock remains 70% below its all-time high of $80 in March 2000.

And Cisco’s price-to-earnings ratio based on 2004 estimated earnings is 34 -- which is high compared with many stocks but far below the P/E of 200-plus it sported in 2000.

The idea of a bubble also is disputed by many analysts who say that investors are far more sober in their expectations of future returns than in 1999 and 2000.

Few market pros expect share prices to continue rising at last year’s pace. Most say gains in key indexes such as the Dow and the S&P; 500 might be in the high single digits at best this year as investors grow more cautious.

A Dow gain of, say, 8%, would be a far cry from the heady returns of the late-1990s bull market. But it would be well above returns on competing investments, such as the 1% or lower yields on bank savings accounts and money market funds, and the 5% or lower yields on government bonds.

The poor returns available on bank and money funds, in particular, are likely to help fuel the market as investors look for something better, analysts say. More than $5 trillion is sitting in those accounts.

“You don’t have to go far to find someone with a lot of cash earning 1%,” said Milton Ezrati, senior economic strategist at investment firm Lord Abbett & Co. in Jersey City, N.J.

Besides betting on continued economic growth, investors who are bullish on stocks for 2004 see history on their side. Big market turnarounds rarely have petered out in less than one year. And stocks have risen in presidential election years about 80% of the time since World War II, according to Standard & Poor’s.

The S&P; 500 index’s average gain in election years has been about 9%.

The market often wins in election years because incumbent presidents do whatever they can to fire up the economy, analysts note.

This year, the economy is expected to continue to benefit from the personal income tax cuts approved by Congress last May and from federal business tax incentives aimed at spurring capital spending.

Other than terrorism concerns, perhaps the biggest wild card for stocks is whether the Federal Reserve begins to raise interest rates -- either because the central bank fears that inflation will rise with the economy’s pickup, or because it feels forced to do so to try to prop up the falling dollar, for example.

Pessimists like Tice believe that a jump in interest rates this year would quickly puncture both the stock market rally and the housing market. That, in turn, could slam the economy and trigger the kind of deflation, or broad-based decline in prices, that Fed officials in the spring warned was a possibility, albeit a remote one, they said.

“All the great recessions and depressions have followed asset bubbles,” Tice said.

But most Wall Street pros say the bears exaggerate what could go wrong and are underestimating the U.S. economy’s resilience, given surging worker productivity, booming corporate earnings, low inflation and the fiscal and monetary stimulus already in the pipeline.

“I think we’ve got enough stimulus to keep us afloat for an awfully long period of time,” said Ned Riley, chief investment strategist at money manager State Street Global Advisors in Boston.