Too early to gauge depth of the downturn accurately

The final quarter of 2001 begins with investors facing a mountain of economic and political uncertainty. Even before the terrorist attacks of September 11th, stock markets had been falling in response to weakening global economic conditions. Despite a strong bounce back in share values during the final week of the third quarter, most major global stock market indices suffered their worst quarterly decline since the fourth quarter of 1987.

The magnitude of these declines can be seen from the accompanying table. In the US, the Dow Jones and Nasdaq fell by 16 per cent and 31 per cent respectively, while, in Europe, the FTSE Eurotop300 registered a quarterly fall of 19 per cent. The Irish market in fact performed somewhat worse than its global counterparts, with a fall of over 22 per cent during the third quarter.

The fourth quarter has begun with widespread cutting of corporate profit forecasts from investment analysts across all the main markets. In the US, expected third-quarter earnings growth for S&P 500 constituent companies is now put at a 19.4 per cent decline by Thompson Financial/First Call. It is generally expected that this forecast decline will be even greater by the time US companies actually report their third-quarter earnings.

In the Republic, local broking houses have been in something of a race to adjust their earnings forecasts downward for this year and next. Over recent months, it had become increasingly apparent that the Irish economy was slowing quite sharply. Recent developments in the global economy have only served to exacerbate these negative trends and it is now clear that Irish companies will be operating in a very difficult climate over at least the next 18 months.

Another factor worrying investors is that October can often be a very bad month for stock markets. The stock market crashes of 1929 and 1987 occurred in October and, if asked, most investors would probably say that share prices are often very volatile and weak at this time of year.

However, it should be of some comfort to investors that October's bad reputation is somewhat misplaced. According to the Stock Traders Almanac, which covers the US stock market, September is in fact the worst performing month of the year - October only ranks as the seventh worst. Furthermore, November and December tend to be very positive months for the US market. So, if seasonal patterns offer any guidance, there is some ray of light for battered stock prices over the remainder of the year.

Even if the fourth quarter of 2001 turns out to be positive for stock markets, probably the best that can be hoped for is that a modest portion of this year's losses can be recouped. The figures showing the year-to-date returns highlight just how severe these declines have been.

Not surprisingly, the worst-performing index has been the technology-laden Nasdaq, which has fallen by 39 per cent over the nine months to end-September. More broadly based indices such as the the FTSE100 and the FTSE Eurotop300, which covers the top 300 European companies, are down by 21 per cent and 26 per cent respectively in the year to September 28th. The ISEQ has declined by a somewhat smaller margin over the same period, reflecting a relatively good first half of the year.

Despite the array of political and economic risks now facing investors, the odds seem reasonably high that the fourth quarter will prove to be more benign. At current levels, share prices probably now discount much of the bad economic news.

It will be some months before analysts will be able to confidently assess the likely depth and duration of the downturn. Until this occurs, and until the nature of the military response to the terrorist attacks becomes clearer, any recovery in share prices is likely to be very tentative.