Update Your Investment Outlook for 2004

The easy money made after an extreme marketlow in prices and psychology is nowbehind us. Pessimism about war and joblosses caused a final ill-timed rush to bondsin the first quarter of 2003 and completed the stockmarket bottom. Last March, 84% were bond bulls, anextreme by any measure. Spotting the inflection pointwas easy because the vast majority had given up onstocks and only 16% of the population wanted toown them. The following are developments to keep aneye on in 2004:

• Political backdrop. President George W. Bush isanxious to avoid being a one-term president like hisfather. The economy must be humming this fall forhim to win reelection, which means jobs must be onthe upswing then. Since high oil prices are a significantdrag on our economy, they also must be held in check.

• Key stock selection. In a spotty economy, not allcompanies thrive, so stock selection becomes critical.Because of the reverse of the bubble environment ofthe late 1990s, a rising tide is not likely to float allboats. In 2004, active managers should continue tobeat the stock indexes handily as they did last year.Find yourself a great stock picker and your portfoliowill thrive. Avoid index funds.

• Weakened bonds. Bonds are not likely to bewinners in 2004. In 2003, bond holdings representedlost opportunity, offering only about a 2% real returnon invested funds (a gain of 4% minus inflation of2%). Next year, as rates start to rise with an improvingeconomy, they are likely to cost you real money.

• Rating changes. Analysts are now so beleaguered,they are frantically raising and lowering ratingsfar too frequently. The temporary blips in stockprices caused by these rating changes can create idealopportunities if you are armed with the knowledgeand conviction that comes with doing your ownresearch. Think of Nextel, unpopular for manymonths and now universally adored, as an example.Providian has been bouncing for 3 months near 11,but should eventually move toward 20 as the creditresults on its loan portfolios continue to show substantialimprovement during 2004.

• World politics. Geopolitics may override all else.Hussein was captured in December. That puts thefocus back on Osama bin Laden, the real perpetratorof September 11, still at large after 2 years. Pay closeattention to increasing unrest and riots in SaudiArabia. If bin Laden succeeds in his primary goal oftoppling the Saudi royal family, oil supplies to theUnited States would be severely disrupted.

• Dollar trouble. The course of the dollar willaffect the US stock market. A falling dollar is a seriousdisincentive to foreigners to hold US stocks andbonds. Their investments are worth less as the dollardrops against their home currency. Last year, aEuropean investor could have made 25% on his USinvestments and then lost 20% on the value of thedollar when those gains were translated back to theeuro. Oil trades in petrodollars, but that may changeif the major oil producers don't want to accept deflateddollars as payment for their oil, unless oil pricesskyrocket as an offset.

• Lofty requirements. A successful investment yearwill require higher corporate earnings, an improvingdollar, better relations with our foreign allies, highercorporate spending, lower unemployment, steady oilprices, success in the war on terror, and more optimismon all these issues at home. Any further terroristattacks on US soil would be very disruptive to oursecurities markets and would not be a plus for Bush'sreelection. That's not a small list of obstacles, which iswhy I expect more modest gains in 2004. There hasbeen no discernible pattern in investment results inelection years since World War II.

Joan E. Lappin is chief investment officer ofGramercy Capital Management in NYC. Gramercyhas been ranked number one in Nelson'sDirectory of Registered Investment Advisors. Itsgrowth portfolios were up in the mid-30s for2003. To attend a midwinter seminar, call 212-935-6909. Lappin welcomes questions or commentsat jlappin@gramercycapital.com.