In all the global gloom, there is evidence the market is close to its low point, writes Jane O'Sullivan

It has not been a good start to the New Year for equity markets.

After a promising beginning in the early days of January, share prices around the world have since fallen back to multi-year lows, hit by the spectre of war in Iraq.

Add to that the continued weakness of the world economy and a belief that equity valuations in the US have still not reached realistic levels and the prognosis does not look good.

"The trouble is the market is about sentiment and the only sentiment out there is fear. And that is coming on top of a lot of economic uncertainty," one Irish fund manager said this week.

On Monday, the Dow Jones index of US blue-chip shares dipped below the 8,000 level for the first time since last October.

Even harder hit has been the FTSE 100, which has tumbled by nearly 12 per cent over the first 29 days of the year, while in Dublin share prices have lost close to 5 per cent of their value.

All in all, it has not been an auspicious start to a year many hoped would mark the end of the most prolonged bear market since the 1940s.

Whether equity markets can recover in the months ahead or whether we are in for a fourth year of negative returns will first and foremost be determined by the outcome of the situation in the Middle East.

It may be a truism to say there is nothing financial markets like less than uncertainty but there is an almost universal acceptance that until there is clarity on the situation in the Middle East, equity markets will remain under pressure.

Wary investors are continuing to pile into safe haven assets like government bonds, cash and gold and will do so until it is again safe to consider a riskier asset class like shares.

The best case scenario for the stock market at this point appears to be a quick resolution of the Iraqi situation which could see a strong rally in share prices as happened during the first Gulf War 12 years ago.

But many market-watchers believe this time could be different. The world has become a more complex place since the September 11th attacks on the US and even if Saddam Hussein is quickly defeated, the terrorist threat remains.

Indeed, one of the more sinister conspiracy theories doing the round of the markets of late blamed the recent sharp falls in London share prices on terrorists shorting the market ahead of an attack, as many believed happened in the US ahead of September 11th.

The war in Iraq has also cast a shadow over the world economy.

With most countries already struggling with the economic slowdown, the fear of war has hit consumer confidence, sent oil prices higher and prompted companies to postpone investment and spending decisions.

The general feeling among analysts is that it is serving to delay the much hoped-for economic recovery.

A long drawn-out war, which spreads from Iraq to other oil-producing countries, would be the nightmare scenario, disrupting oil supplies and postponing both corporate and consumer spending indefinitely with serious implications for the global economy.

But even if war is taken out of the equation, it is far from certain that stock markets are set for recovery in the near term.

Speaking at the World Economic Forum in Davos last week, Deutsche Bank chief executive Mr Josef Ackermann noted that even a positive resolution to the Iraqi situation would not resolve the fundamental issues weighing on markets.

"We are adjusting from an equilibrium at a very high level to an equilibrium at a very low level and this is an adjustment that is costly and it will just take time."

Equity strategists generally believe that the US equity market, which sets the tone for stock markets around the world, remains overvalued at index level following the "irrational exuberance" of the boom years.

NCB Stockbrokers estimates that the US market is currently trading at around 21.5 times trend earnings compared with a fair value of just below 17 times.

However, NCB equity strategist Mr Bernard McAlinden says European markets generally offer very good value, particularly when compared with government bond yields.

Many stocks are now offering a dividend yield of around 4 per cent, broadly the same as bonds.

But does it make sense for investors to be getting into European stocks when the US market, from which they largely take their cue, may still have further to fall?

Investors in European equities also have other issues to consider before taking the plunge.

Germany may be one of the cheapest markets around but worries persist about the weakness of its economy.

UK shares are also relatively cheap but concerns about the solvency of insurers continue to weigh on the London market.

The chairman of the UK Financial Services Authority, Sir Howard Davies, has said the sector appears to face no solvency issues down to a level of 3,500 on the FTSE 100 index while others believe it is safe down to 3,000.

But with the UK market not so far off these levels, fears of insurers being forced into distress selling of equities remain an issue.

But some see in all the gloom, evidence that the market is getting close to its low point.

"It is often the case that when things are at their worst, when all you see are the negatives things around, that things are coming close to the bottom," one fund manager said.

Or as NCB's Mr McAlinden points out: "It's becoming as crazy now to be getting out of equities in Europe as it was crazy to get into them in 1999/ 2000."