for investors in the year ahead is: stay cautious. Ahmed ElAmin reports.

The last half of 1998 left investors rattled and wondering what strategies to take in the year ahead. Royal Bank of Canada analysts have looked back at the past and through their crystal ball see a bad year ahead.

What you do to survive the coming decline, and how bad it will be is the next question. Given an uncertain outlook the analysts believe equity market investment returns will remain moderate in 1999, and advise caution until the bull comes charging back.

The analysis is stated in the Royal Bank's quarterly International Investment Outlook report, provided by Royal Trust (Bermuda) Ltd.

After one of the most volatile years on record the Royal Bank analysts see a pattern heading towards a bear market -- one in which after a high, stock prices decline.

"Reviewing the phases of the stock market cycle, it is evident that the US stock market is on the verge of entering phase three -- the final stage of a bear market,'' they stated. "The same can be said of most markets that tend to follow the direction of the US, particularly those in Europe.'' The analysis is based on studies of the bellwether Dow Jones Industrial Average going back to the crash of 1929. The analysts believe the first two stages of a cycle have already occurred.

"Bear markets bottom out at least one quarter ahead of a period of economic recession or significant slowdown, when market sentiment is darkest,'' they stated. "Phase three usually begins as a recession or significant economic slowdown starts to bite, and typically ends three to six months before an economic recovery begins.'' Phase one is described as a sharp, usually brief, fall from the highest levels of the bull market, and indicate an economic slowdown. Typically the fall takes place as corporate earnings fail to meet projections.

This phase occurred in the second half of last year when in October the market fell back 30 percent from the overvalued levels at the top of the bull market in 1998, the analysts stated.

The setback was followed by phase two, the full rebound from those losses in the final quarter of the year.

"Entering into phase three, the most important question now is how long the final bear market phase will last, and how severely it will affect equity prices,'' the Royal Bank stated.

Mitigating factors indicate that major lows in the equity markets are not likely in the foreseeable future. These include the aggressive reduction in US and global interest rates. The action by the US Federal Reserve Board to reduce key interest rates at a time when equity markets were so highly valued was a first.

However the worrying concerns are over an expected economic slowdown followed by a deterioration of corporate earnings. To meet forecasts many companies have cut discretionary spending and capital expenditures. About 40 percent of companies reported earnings declines in the third quarter 1998.

"Clearly, there are limits to this kind of financial engineering and some top-line growth will be needed to avert earnings disappointments,'' the analysts stated.

Other concerns are the threat of deflation, continuing international uncertainty in Asia, Latin America and Russia, the Year 2000 computer problem, and political issues in the US and Europe. The political concerns are the potential impeachment of US President Bill Clinton and a political shift to the left in Europe.

"Given these cautionary signals, it is our view that equity markets investment returns will remain moderate in 1999,'' the analysts stated.

"However, despite the market's strong recovery toward the end of 1998, returns from US equities are likely to be lower than those in much of the rest of the world during 1999.'' Looking ahead in the US the analysts expect earnings growth for the Standard & Poor's 500 Index to be three percent for the year, with a gross domestic product growth of 1.5 percent.

Gloomy outlook for investors Canada remains vulnerable to economic swings. The analysts paint a gloomy picture of Canadian corporate profit growth. The market could get a boost in the second half if commodity prices stabilise then rise.

Latin America's outlook remains "worrisome'' while Asia is expected to recover in the second half of 1999. Japan continues to perform poorly with ongoing massive restructuring.

The analysts have a more positive outlook on Europe and expect continuing strength throughout the year.

December 31 the analysts recommended investors go overweight on bonds. They recommend a US-dollar based balanced portfolio with 54 percent in bonds, 36 percent in equities, and the rest cash.

In equities they recommend 41 percent holdings in the US, 25 percent in the European Monetary Union (EMU) countries, six percent in non-EMU, 14 percent in the UK, ten percent in Japan, two percent in Canada, and one percent in Australia and New Zealand combined.

They recommend fixed income holdings of 43 percent in the US, 21 percent in the EMU, 14 percent in non-EMU, ten percent in Japan, nine percent in the UK, and three percent in Canada.

BUSINESS ROLLERCOASTER -- The chart shows The Royal Bank of Canada outlook on the economic well-being of several countries and regions' ranking in relation to the business cycle. The bank's analysts evaluate political and economic country risk, market liquidity, and fundamental investment worthiness.