There’s no question the markets were red hot in 2003. Now investment professionals say the question is whether the markets will burn investors in 2004.

The Dow surged 25 percent in 2003, the Standard & Poor’s 500 index was up 26 percent, and the Nasdaq rose 50 percent, its third-best one-year gain in history.

The numbers were a welcome sign of relief for investors who saw their portfolios and retirement accounts decimated during a bear market that began three years ago.

Investment professionals, though, said such big gains should raise red flags.

“They sound like good numbers, but I think they mean we need to be cautious,” said Larry Swinson, branch manager of Lawrence’s Piper Jaffray office. “I think we could be setting ourselves up for a pretty severe correction.”

It is hard to find any investment adviser who is predicting that 2004 will be as robust as 2003.

“In 2004, the first issue is for individual investors to get their expectations in line,” said Robert Froehlich, chief investment strategist for Deutsche Asset Management in Chicago. “Now that the Nasdaq is up 50 percent, many might believe we’ll get 50 percent gains from here to eternity. But 2004 won’t be as strong.”

That’s not to say 2004 is expected to be for the dogs. Many analysts are predicting the markets to finish higher than they did in 2003, but they’re not expected to grow at such a fast rate.

“I think the trend is still in an upward direction,” said Wayne Whitney, president of Lawrence’s Whitney Financial Group. “I’m not optimistic we’ll see that (2003) type of growth again. We’re telling our clients that we think the market will regress back to more normal returns of 8 or 9 percent over the long term.”

Members of the Times Square Alliance, which helps to put on the annual New Year's Eve celebration in Times Square, celebrated the new year early with a shower of confetti at the Nasdaq MarketSite in New York. The celebration Wednesday was appropriate; the Nasdaq finished 2003 up 50 percent for the year -- the index's third-best year on record.

’04 strategies

Figuring out how to make money in the market this year may be a bit trickier, but many analysts agree that stocks should be a better play than bonds.

“I think people who are interested in making some money need to be in equities,” Whitney said. “I don’t want to be too heavily invested in bonds. The next interest rate adjustment probably will be up rather than down.”

This year, investors should brace themselves for a rise in interest rates by the Federal Reserve, Swinson said.

“It is not if, it is when,” Swinson said of a rise in rates. “That’s why you have to be careful with bonds right now. You don’t want to go long-term with bonds.”

But he said he didn’t think a rise in rates would cause the stock market to go into a swoon.

“The rising interest rates will take place, but the reason the Fed will raise the rates is because the economy is on the rise. The markets will recognize that.”

Some advisers also are recommending investors look at changing their mix of stock holdings. David Chalupnik, head of equities for U.S. Bancorp Asset Management, said now may be the time to get out of some high-tech and small-growth stocks, which are the two categories that led the rally in 2003. Instead, he suggests looking for larger-cap stocks with broader balance sheets.

“This is not the time to leap into aggressive-growth funds,” Chalupnik said.

There may be one other reason to think 2004 will post stock market gains: the presidential election.

“Our history tells us that election years are usually good years,” Swinson said.

According to the Stock Trader’s Almanac, stocks have posted an average gain of 7.3 percent in presidential election years. But the almanac also reinforces the idea that 2004 won’t be as strong as 2003.

The book said the third year of a presidential term, like 2003, almost always produced larger gains than the final year of a term. Experts say that is because incumbents usually begin “juicing” the economy with new programs to gain votes in the third year rather than the fourth.

’04 risks

Whitney said job growth and consumer confidence numbers would be telltale economic reports for investors to watch in the coming year.

He’s optimistic that both will be on the rise this year, but there are several risks that could derail the economic good times. Another terrorist attack on domestic soil is at the top of many analysts’ lists of dangers.

“The terror issue is the biggest threat hanging over the market,” Whitney said. “The market is so psychological. If we had another Sept. 11-type event, it would really spook the market.”

Another big concern of analysts is that investors will overvalue stocks and create another bubble similar to the technology bubble that burst in 2000.

“I don’t think we’ll have another bubble, but greed is a strange thing,” Whitney said. “When investors start seeing tech stocks go up 50 percent, it is tough for them to not jump in.”

Swinson said that was why some of the numbers posted in 2003 have concerned him.

“Frankly, I don’t think it is good to have the market go up 25 percent in a year,” Swinson said. “It creates a euphoria that is dangerous.”

— The Associated Press contributed to this report.