INVESTOR: Stock markets began the opening weeks of 2002 in fine fettle as economic data releases gave increasing credence to the view that the US economy would recover early this year.

However, it did not take long for bearish forces to regain the ascendancy as the negatives that have been afflicting sentiment for over 18 months reasserted themselves.

The critical negative factor has been weakness in corporate profits, and in the opening month of the year the financial results from corporations generally failed to live up to (much reduced) expectations. Furthermore, the statements from company chairmen usually accompanying these results were uniformly downbeat.

The end result has been a further decline in share prices during January, reflected in negative returns from the majority of stock market indices.

In America, the S&P 500 and Nasdaq indices both declined by approximately 2 per cent, whilst in Europe declines of a similar order of magnitude occurred. The Dow Euro Stoxx index, which covers the top 50 European companies, produced a negative return of 3.2 per cent over the month.

In the Far East, gloom continued to envelop the Japanese market, which fell by more than 7 per cent in January. This means the key Nikkei 225 index has now fallen below the Dow Jones 30 index in the US for the first time since 1952. It is hard to believe the Nikkei 225 reached a peak value of over 38,000 in the late 1980s.

Closer to home, the ISEQ index declined by 5.7 per cent in January but there was a very large disparity in performance between financial and non-financial stocks.

The ISEQ General index, which measures non-financial stocks, declined by just over 12 per cent in January, compared with a rise of 7 per cent in the financial index. This would seem to indicate investors were buying into the relative safety of financial stocks in the opening weeks of the year, and shunning industrial companies.

However, this is an usually wide gap in relative performance and is a little puzzling. The accompanying table shows the top three and bottom three performers in January, together with actual returns from the main financial stocks. Analysis of the information in this table highlights some key trends in the opening month of the year.

Firstly, there are no financial stocks in either the top three or the bottom three performers. Irish Continental Group and Jurys Doyle performed strongly as the share prices of both companies continued to recover from their post September 11th lows.

The most notable of the laggards is Elan Corporation, which fell by a massive one-third in January. A negative article concerning its accounting policies in the Wall Street Journal combined with delays in the clinical trial for its Alzheimer's drug led to the wave of selling, which has continued this week on the back of a profits warning.

At the beginning of the year Elan on its own accounted for 23 per cent of the overall ISEQ market capitalisation, and accounted for 35 per cent of the total capitalisation of the ISEQ General index. Therefore, Elan alone accounted for 11 percentage points of the 12 per cent fall in the General index. Furthermore, if Elan is excluded from the overall ISEQ index, we find that the decline of 6 per cent is transformed into a rise of approximately 1.5 per cent.

This analysis highlights that once the dramatic decline in the Elan share price is excluded, the disparity between the financial and non-financial sub-sectors is much reduced. The relative out-performance of the financials now falls to about 6 per cent compared with the almost 20 per cent out-performance when Elan is included.

This is consistent with the actual returns shown in the table of financial stocks. Share price gains ranged from the 9.8 per cent return achieved by Irish Life & Permanent to the more modest gain of 4.4 per cent achieved by AIB. However, Wednesday's dramatic developments at AIB will cast a cloud over that bank for some time. Despite this, the rest of the financial sector can probably continue to produce solid returns, provided the Irish economy continues to outperform its European counterparts.