A YEAR ago, many people in the investment management industry felt the bear market was about to come to an end - but for the third year in a row the equity indices showed a fall.
At the beginning of 2002, the FTSE 100 index, which measures the performance of the top 100 companies in the UK, stood at 5,217. At the close of trading on Hogmanay, the index had dropped to 3,940 - a fall of 24.5%.
And even though by Friday the
FTSE 100 had achieved its biggest weekly advance since August, closing at 4,004.9, analysts were left ruing a woeful year for equities at a time when many had forecast recovery.
Andrew Milligan, head of global strategy at Standard Life Investments says: "Last year was a difficult one for investors and the financial services industry.
"It offered the threat of war in the Middle East, further acts of terrorism, corporate fraud, investment banking scandals and the fear of double dip recession.
"This all culminated in falling equity markets. As a result, 2002 will be the first time since the 1940s that the UK stock market has fallen for three years in a row."
Andrew November, the head of global strategy at Scottish Widows Investment Management, admits he was not forecasting that the market would fall.
"We expected the FTSE 100 index to be way above its current level," he says. "We were expecting the markets to move sideways over the last 12 months, rather than for them to go down then back up again."
November did not believe there was a catalyst to bring the markets down. "The corporate shenanigans that we saw during 2002 helped the markets to fall. It means that our estimate of the finishing position of the FTSE 100 index is out by about 1,200 points."
James Anderson, the manager of Scottish Mortgage investment trust, feels his predictions were flawed and erratic. "I was particularly surprised by the extent of forced equity selling by UK insurers that again prevented worthwhile out-performance by the British market relative to America," he says.
So will there be better fortunes for equity investors in 2003? Many experts are cautiously optimistic that things will improve by the end of the year, although it could be a rollercoaster ride.
"Looking ahead to 2003, we are confident that the moderate recovery in the world economy will remain in place, and policymakers will take the necessary steps to create an environment where companies can make profits," says Milligan.
"As a result, we believe that with careful stock picking the stock market has the potential to offer good returns. Investors should take this opportunity to reappraise their investments in bonds, equity, property and cash to ensure they have an asset mix appropriate to their own circumstances."
However, November feels the FTSE 100 index will continue to be volatile, estimating the levels at between 3,500 and 4,500. "The index could reach both ends of the spectrum several times," he says. Nevertheless, he believes that by the end of 2003, the index could be at the upper end of the estimate.
Anderson agrees. "The UK market will lurch around fairly violently," he says. "It lacks the confidence and institutional buying to ignore political and military upheavals and will struggle to escape from slavish imitation of America.
"But by the end of the year it is likely to be around 4,400 as modest earnings growth and some valuation support will gradually allow poise to be recovered."
Experts feel there are a number of factors that will affect markets in the coming year. "Chief among these will be the resilience of consumer spending and the housing markets in the US and UK, the tax package from the Bush administration, banking sector reforms in Japan, and the pace of structural reform in Europe," says Milligan.
November sees the UK market as reasonably valued, but that unless it is disconnected from the US market, it could be difficult for the UK to perform. "If we can disconnect from the US market, the UK could perform," he says. "But it is hard to rally against the US markets falling."
The possibility of a war in the Middle East could have an effect on oil prices as well as how markets will react. "Overall there will be uncertainty about possible military action in the Middle East.
"Markets are liable to remain volatile as long as this issue persists and oil prices remain high," says Milligan.
November agrees. "A war will be a potential issue," he says. "If it is reasonably contained and the price of oil comes back, there may not be too much impact. But the longer oil remains at over $30, it will be more difficult for the economy to grow."
Robert Waugh, the head of UK equities at Edinburgh Fund Managers, adds: "The threat of conflict in Iraq and further terrorist shocks represent a major risk to the stability of the global financial system in 2003 and beyond."
Asked which markets will perform well during 2003, economic experts generally agree. "The fundamentals of the UK economy remain strong, with low inflation and employment near record levels," says Milligan.
"The US markets will benefit from more aggressive policy measures than their German and Japanese counterparts. The threat of worldwide deflation is receding, and as government efforts at reflation gather pace, emerging markets such as the Pacific Basin should benefit."
November agrees that the UK and emerging markets could provide encouraging returns. "In the UK, the valuations are reasonably good, while the emerging markets are in reasonably good shape," he says. "Emerging markets have been through a crisis before now and have come through that."
Anderson adds: "Emerging markets still appeal to us. Eastern Europe ought to do well again." As to whether the US will return to form as the key driver of markets, November believes that this has been the case over the past few months. "The US has been driving markets - down," he says.
"It is unlikely that the US will do well in relative terms," says Anderson. "The Federal Reserve and the Bush administration are engaged in desperate policy stimulus that is deferring rather than solving problems.
"This has begun to upset the dollar and may continue to do so. In too many sectors America has squandered its leadership by a combination of greed and weakening research."
So what should investors consider before deciding to invest in equities? The main criterion is the level at which they are buying. "There is no sense in people buying at the top of the trading range," says November.
Anderson adds: "Investors should always consider if they have the resources and the patience to endure volatility in share prices."
The general consensus of the investment experts is that the markets in 2003 will continue to show volatility. Investors should hold on tight for a bumpy ride.
