Forget the optimists. Be careful out there

Finance and property experts say they expect a good year, says William Kay. That's what they said at this time last year

This is the peak season for annual predictions, when normally hard-headed fund managers and financial advisers magically become soft-hearted optimistics who insist on seeing a silver lining to every cloud, a sunny upland beyond every vale of tears.

Low inflation, interest rates and unemployment are the stable background to concerns about whether house prices are about to collapse, or whether share prices can finally pull themselves out of their three-year dive.

In most years, it is a good rule of thumb to assume the opposite of what the experts are predicting. If that holds true for 2003, then their generally modest optimism suggests that a modest dose of pessimism is in order. None of the major forecasters can bring themself to see the FTSE 100 index ending this year below 4000 compared with the 3940.4 at which it began on Thursday.

"War with Iraq, low global economic growth, and the threat of deflation will continue to cast a shadow over equities in 2003," forecasts Chris Tracey, investment director of JPMorgan Fleming Asset Management. "Yet I anticipate positive stock-market returns, with government bonds underperforming."

Jeremy Tigue, head of investment trusts at F&C Management, predicts that the FTSE 100 index will be around 4200 in a year, nearly 7 per cent better than the level at which it ended 2002. This contrasts with the gung-ho hopes of a year ago, when David Rough, then investment director of Legal & General, was among those forecasting that by now the index would be above 6000.

Mr Rough has retired but Andrew Clare, financial economist at Legal & General, now says: "In the UK, the themes for 2003 will be very similar to those in 2002. Government spending and consumer spending will remain strong, in a low interest-rate environment and high levels of employment. And the beleaguered manufacturing sector, which exports 40 per cent of its output, should benefit from growth in the global economy. The UK is likely to become less of a twin-speed economy in 2003."

Mr Clare thinks the UK equity market is undervalued and, left to itself, the FTSE 100 index would rise to between 4600 and 5200. But, he says, it faces "significant headwinds", notably institutions looking to switch from shares to fixed-income securities, so he opts for the low end of his range and predicts 4600, which would still amount to an impressive 17 per cent rise.

Most experts cite the probable debilitating effect of the continuing Iraq conflict as a drag on share prices hard to quantify and hard to predict, along with the associated threat of further terrorist attacks.

Bob Yerbury, the chief investment officer of the Invesco Perpetual investment group, says: "Despite a strong stock-market performance over the past couple of months, this is the worst sustained bear market since 1973-74. Corporate scandals in the US have not yet been satisfactorily addressed and longer-term issues – the threat of war, lack of pension funding, demographics, etc – continue to impact on markets and investor sentiment.

"But we remain positive going into 2003. Interest rates are at the lowest for 40 years, valuations for UK and Europe are looking cheap and we find many undervalued companies with good long term growth prospects; these are most likely to be in the biotech, telecoms and construction sectors."

Patrick Evershed, manager of the New Star Select Opportunities Fund, says: "I don't expect the market to rise substantially over the coming year. It is more likely to stay range-bound about present levels. For this reason, it will continue to be hugely important to select carefully the companies in which you invest. In an environment of low economic growth and flat equity markets, it will be easier for carefully selected small companies to out-perform because of their size, which makes them less correlated to the general economy." Mr Evershed likes technology, healthcare and Lloyd's insurance companies.

Michael Jones, the head of UK Third-Party Retail at Merrill Lynch Investment Management, sternly urges investors to pay down debt as a priority for 2003, and keep powder dry. "The market doesn't feel like it's at the start of uptick," he said, predicting a flat half-year followed by a recovery in the second half to score a small rise in share for the year.

"Income is going to become more important, and if we can get a 4 per cent return from dividends and 4 per cent from capital gains, that may be boring but boring is pretty good right now."

Merrill Lynch runs 2002's most successful fund, Gold and General, and Mr Jones expects this to do well again this year. "We think the gold run has further to go, helped by geopolitical uncertainty and the weakness of the dollar. But whatever happens markets will be volatile." But investments rarely do well two years running.

If it is hard for fund managers to peer through the gloom surrounding share prices, bulls of the housing market are showing worrying signs of exhaustion.

Ray Boulger, senior technical manager at Charcol, part of the Bradford and Bingley mortgage lender, says: "We predict the annual rise for 2003 will be at a steady, more sustainable, rate, about 5 to 6 per cent. There is concern regarding house-price inflation, and it is unsustainable at the present level. But while interest rates remain low, a widespread negative equity scenario remains extremely remote."

Even to whisper the dread phrase "negative equity" after a 20 per cent rise in house prices this year is to betray the sort of nervousness that has not been seen for some time. But Hamptons, the large estate agent, is even more cautious. Their group managing director, Robin Paterson, says: "The residential property market enters 2003 showing many signs of confusion. We are of the opinion that prices will fall by between 5 per cent and 10 per cent between January and June 2003, with the market then levelling off and there being a 2 per cent to 3 per cent increase in the second half of the year."