Before you decide where stocks are headed in 2003, complete this little Christmas quiz.

Pick the odd one out: a) an unbalanced economy, b) weak companies, c) misleading earnings statements, d) above-average valuations, e) geopolitical instability and f) Dow 11,000.

Unlike many Detox readers, Wall Street's top stock touts are struggling to see anything anomalous in the above list. Just like last year, they're predicting big gains for stock indexes amid what are perfect bear-market conditions. And once again the bulls will be proven wrong because 2003 will be the fourth-straight down year for the stock market.

In fact, the

Dow

and the

S&P 500

would need to fall at least another 15% apiece to become reasonably valued, while the

Nasdaq

needs to shed 300 points from here to find a floor. And there will be much else beyond lackluster earnings and pricey valuations to unnerve investors next year. Here's a short list: more accounting scandals, a weak dollar, a panicky central bank, problems in foreign economies and the little matter of a shooting war in the Middle East.

Piggy Bank

First, earnings. This year, it's been very hard to see what companies are actually making, due to the heavy use of restructuring charges. Companies can bury core expenses in these charges. Wall Street follows something shady called operating earnings, which generally leave out charges. Operating earnings are predicted at $47.17 for the S&P 500 in 2002, way higher than the $31.69 for net earnings, which include charges and other items.

A midpoint between those two numbers -- $39.43 -- would give a rough approximation for real operating earnings. Boost it by a generous 15% to reflect an earnings recovery in 2003, and the S&P 500's true profits next year could be $45.35. If we say stocks should trade at 15 to 16 times that number -- again, charitable -- the S&P 500 index would be fairly valued at between 680 and 725. Outlandishly low? Not when you consider stocks touched 769 this year. The index has recently been around 880.

Five Stocks Shine in Dreary Year

Networking: Next Year: Cisco, Juniper and Red Ink

Cisco Shift Gums Up the Works for Rivals

Homeland Security: Firms Scramble to Cash In

Wireless: Pinning Hopes on Shutterbugs

Consumer Debt: Looks Set to Keep Soaring

War Optimists May Face Pricey Surprise

Oil: The Price Outlook Is Clear as Mud

Credit Crunch Could Chew Up Lenders

But the S&P 500 won't fall straight to 700 while the

Federal Reserve

is conducting a loose monetary policy by slashing interest rates to the sort of lows typically seen only in dire emergencies. The central bank is fighting hard to keep stocks higher to shore up the asset side of people's balance sheets at a time when the personal debt burden -- on the liability side -- is at its heaviest since statistics were kept.

The Fed also wants people to stop saving, because doing so crimps consumption, and low rates help keep money out of savings accounts. Though the Fed's push to make the average guy rely more on flimsy paper asset wealth (such as stocks) over cash savings is deeply harmful in the long run, the central bank can easily work its black magic for a while.

Nothing Gold Can Stay

But there are signs that the market has had enough. The two starkest signs of this are gold's 25% rally through 2002, and the recent collapse of the dollar against the euro. Investors prefer to hold other currencies and the yellow metal over the dollar because they think they'll lose less of their value.

The reason? They can see the Fed is aggressively expanding the supply of greenbacks. And the strong growth in money-supply indicators reflects high growth in loans to individuals, who use the credit to buy houses and cars. That means the credit is being used not to improve productivity, but to boost consumption. And when this lending binge stops, demand will weaken and act as a drag on growth.

So how do economies normally work themselves out of a hole like this? Individuals and companies reduce their debt burdens in a recession. We have had no recession, so there has been no debt reduction. And that means no sustainable growth.

The Fed also can't do much to prevent more damaging developments in corporate America. Lenders will feel more pain. Credit card lender

Metris

(MXT)

will file for bankruptcy protection in 2003 and

AmeriCredit

(ACF)

will trade under $5 by the end of the year.

Capital One

(COF) - Get Report

looks set to fall to $20 or below. If the bottom falls out of the housing market, impairing mortgages to people of low creditworthiness, many big-name banks could get hit.

In fact, two of the three biggest corporate events of 2003 will be in the financial sector.

Fannie Mae's

(FNM)

earnings will fall well below expectations next year, sparking a strict regulatory crackdown on the government-sponsored behemoth.

Second, the surfacing of serious problems at GE Capital,

General Electric's

(GE) - Get Report

gargantuan finance arm, could drag General Electric stock to as low as $15. The third big corporate story for 2003 will be

Tyco's

(TYC)

struggle to pay back the crushing $12 billion of obligations that come due next year. Only an unprecedented amount of grace from its creditors will allow Tyco to avoid a bankruptcy filing.

The News From Outside of New York

Investors also must contend with negative political events. The likely war with Iraq will turn out to be the cakewalk the hawks expect, causing stocks to rally sharply and oil to plunge in the month or so after Baghdad is taken. And the U.S. colonization of the country won't be problematic for the first two years. No, Iraq becomes a negative only when the Iraqis get sick of being run by the Americans and local guerillas start to target the U.S. military units. Alas, a quick victory in Iraq will be more than offset when Brazil's new president, Luiz Inacio Lula da Silva, decides to default on the country's $260 billion of foreign debt -- probably toward the end of next year.

The Japanese economy will resume its tailspin, going by recent signs that the reformist Prime Minister Junichiro Koizumi has ditched his pledge to cap government debt issuance. However, the really big international economics story for 2003 will be increased discussion of the awful implications of the

inevitable collapse of the Chinese economy. The actual crash may not happen for two years, but the market will start pricing it in next year.

Domestic politics will also be a negative. Expect an Iran-Contra type scandal stemming from abuses by members of the bellicose faction within the White House. Hawks like Defense Secretary Donald Rumsfeld are playing fast and loose and will make a big mistake soon, which his Pentagon foes will duly leak. While a scandal may hurt Bush's chances in 2004, his enactment of sizable tax cuts and a quick victory in Iraq should mean strong approval ratings through 2003, pleasing the market.

Foreigners, however, will not like to see the government's budget deficit swell. This will be another source of dollar weakness. The Fed will have to hike rates more quickly than it would like to prevent an exodus of foreign money.

Happy New Year.

In keeping with TSC's editorial policy, Peter Eavis doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He welcomes your feedback and invites you to send any to

peter.eavis@thestreet.com.