- The Washington Times - Friday, December 31, 2004

The U.S. stock market eked out a second straight year of gains in 2004 — its first in half a decade — boosted by a fall rally after languishing for most of the year.

Two major indexes — the blue-chip Standard & Poor’s 500 and the technology-driven Nasdaq Composite Index — racked up 9 percent gains while the venerable Dow Jones Industrial Average inched up about 4 percent.

All of the Wall Street indexes ended the year at levels not seen since before the September 11, 2001, terrorist attacks. The Dow, clocking in at 10,783 at the close of trading yesterday, is within reach of its record high of 11,723, set in January 2000. The other indexes are still far below the high water marks hit before the tech bubble burst in early 2000.

The market’s momentum at the end of 2004 came as relief on Wall Street, where most gurus had predicted another year of gains, albeit modest ones, on top of 2003’s exuberant returns of 25 percent to 50 percent.

But the market performance was tepid when measured against the stellar returns offered by more junior stock markets in developing countries around the world last year, from Egypt to Eastern Europe and Latin America.

Cairo’s stock index was the world’s best performer, with a 125 percent return, closely followed by Colombia’s index with 120 percent. Stock indexes in Hungary, the Czech Republic, Austria and Estonia soared from 70 percent to 80 percent. Mexico’s market gained nearly 50 percent.

While the three U.S. stock indexes posted returns around their historical averages, they were among the 10 worst performers worldwide.

The high returns of many foreign stocks reflects the more rapid growth characteristic of developing economies. The United States grew around 4 percent last year — about half China’s growth rate, but a robust pace, nonetheless, for a mature economy.

A 9 percent average return “seems a meager reward,” said Bill Cheney, chief economist with John Hancock, “but certainly comes as a relief against the backdrop of the last several years” when U.S. stock indexes plummeted by as much as 80 percent.

Both the U.S. economy and the stock market should perform about the same this year, he said, as the economic expansion moves into its fourth year and growth settles in at a middling 3.5 percent pace.

The obstacles that held back growth last year — rising interest rates and inflation, the conflict in Iraq and high oil prices — are likely to continue this year, but should not prevent another solid year of earnings growth at U.S. corporations, analysts say.

The biggest risk for both the economy and the stock market, Mr. Cheney said, is a more precipitous fall of the dollar, which already has tumbled by nearly 30 percent against other major currencies since 2002 as a result of the burgeoning U.S. trade and budget deficits.

Last year’s relatively poor U.S. stock performance versus global competitors does not bode well for the dollar or the stock market, since it may prompt both foreign and domestic investors to shift holdings overseas to take advantage of higher yields.

The falling dollar in itself diminishes the value of trillions of dollars of existing foreign investments in stocks, bonds and other assets, and acts as an inducement to flee U.S. markets.

“A dollar crisis could begin,” Mr. Cheney said, if the United States continues to lose its edge as a profitable haven for investment.

In particular, interest rates could go sharply higher if foreigners demand higher returns to compensate for a dramatically weaker dollar. That would weaken both the economy and the stock market.

At year’s end, some signs emerged that foreigners were cooling toward U.S. investments. Central banks in Asia, which invested record amounts in U.S. bonds at the beginning of the year, were tailing off investment.

U.S. investors also started contributing to the exodus from U.S. markets last year at the urging of many investment advisers.

Standard & Poor’s is advising clients to invest at least 15 percent of their assets in foreign stocks, either directly or through mutual funds.

“Stocks of non-U.S. companies now make up 48 percent of total global market capitalization,” said the investment firm. “The fastest growing economies in the first decade of the 21st century are likely to include China and India, but not the United States.”

Standard & Poor’s also advises investors to be patient, save more and learn to be satisfied with the still-solid returns in U.S. markets. It projects that an abysmal personal savings rate in the United States of 1.1 percent last year will sink even further to 0.5 percent this year unless Americans change their free-spending ways.

Joseph P. Quinlan, chief investment strategist with Bank of America, said four developments could spur the U.S. stock indexes to double-digit returns this year.

The most important would be a move by President Bush to put “credible” restraints on spending, which he said would ease concerns about U.S. deficits and the dollar among foreign investors.

A big drop in oil prices also would help, he said, as would a pickup in global economic growth or a turn for the better in violence-torn Iraq.

On the other hand, a breakout of civil war in Iraq would drive up oil prices and threaten U.S. markets, he said.

Ralph Acompora, a technical strategist with Prudential Securities, said the current rally on Wall Street is broad and deep, inviting high-quality first-time stock offerings, in a sign the bull run has much further to go.

“We are very bullish,” he said. “We are looking for a minimum 25 percent to 30 percent up from here.”

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