Historical studies of stock market returns show that January is usually a good month for equity investors. A glance at the accompanying table suggests that January 2001 is no exception, with the world index producing a return comfortably in positive territory of 2.9 per cent. This may come as a surprise to many investors, given that the financial pages during January have been full of profit disappointments and warnings from companies as a result of the US economic slowdown.

To a certain extent, the apparently favourable picture painted by these statistics does flatter to deceive. The second column in the table shows the performance for stock markets for calendar 2000 and highlights the sharp falls in equity prices endured by most of the world's stock markets last year. The bulk of the decline in equity prices occurred in the second half of the year.

Viewed in this light, the positive stock market performances in January could be construed as simply a modest bounce within an overall bear market.

But this probably represents too harsh an analysis of the often volatile conditions exhibited by stock markets in January.

The key influence on stock prices in January was the cumulative one percentage point cut in US interest rates announced by the Federal Reserve.

Declining interest rates and bond yields represent a positive influence on stock prices. The decisive shift towards easing by the Fed signals that US interest rates will continue to fall as the year progresses. This will exert a downward bias to monetary policy throughout the world and should enable the British authorities to reduce sterling interest rates in the near term.

Later in the year lower US interest rates will probably allow the European Central Bank to engineer some modest reductions in euro interest rates.

While lower interest rates will certainly act to support equity prices during 2001, the big imponderable remains: will the US economy slide into recession during the year or will it experience a soft landing?

The negative impact on equity prices of a sharp or prolonged US recession would easily outweigh the positive impact of lower interest rates. The economic data with respect to the state of the US economy now point to quite a sharp slowdown in growth, although the jury is still out as to whether this will translate into all-out recession.

Recent data clearly confirm that the manufacturing sector is already experiencing recessionary conditions. However, manufacturing now accounts for only 15 per cent of US GDP so that recession in manufacturing need not necessarily result in a recession in overall GDP.

Although indicators for consumer confidence have declined sharply in recent months, many sectors and geographical regions of the US economy remain in good shape. In the key area of housing, long-term mortgage rates have underpinned a strong market and the pace of new housing starts has recently accelerated.

The labour market remains strong and so far there has only been a marginal increase in the rate of unemployment. Also, according to the Fed chairman, Mr Alan Greenspan, the longterm advances in technology, and gains in productivity, exhibit few signs of abating.

Analysis of January's stock market returns suggests that equity investors are buying into the scenario that the most likely outcome for the US economy is a soft landing. If the unfolding economic data continues to support this outcome, then stock prices in coming months can probably build on the gains achieved in January.