There are various signs that the markets' long climb from the trough they fell into a year ago have reached their peak, reports Deborah Hargreaves.

A year ago, markets round the world were plummeting, share prices in the UK had slumped to an eight-year low and the ISEQ index of Irish shares was at its lowest level since 1997.

In Britain and the euro zone, the benchmark government bond yield had surpassed the market's dividend yield for the first time in almost 50 years.

Hendrik du Toit, chief executive at Investec Asset Management, declared it the best buying opportunity of his lifetime. So far, he has been proved right.

March 12th, 2003, proved to be the trough in Europe's worst bear market since the 1929 Wall Street crash. Since then, the FTSE 100 has rallied by more than 30 per cent. The FTSE 250, which contains more technology stocks exposed to the world economic recovery, has risen by 60 per cent.

US technology stocks have led the way among global markets, with the Nasdaq Composite up 53 per cent over the past year and the broader S&P 500 registering gains of nearly 40 per cent.

Over the same period, the ISEQ has risen 36 per cent.

But this week's sell-off - eroding all of 2003's gains on the leading US indices - has raised doubts among investors about whether the recovery is flagging.

Many investors have fled to bonds in the past two days amid renewed fears about international terrorism following the bomb blasts in Spain, even if equities did edge higher late on Friday.

Others have switched out of shares most exposed to recovery - technology and cyclicals such as car manufacturers - and into more defensive sectors.

One of the reasons for this is the fear that the US economic upturn may prove to be fragile. Last week's jobs data, which showed the private sector created no new jobs in February, reinforced those concerns.

The past year's rally has also left many shares, particularly in the US, looking expensive.

Warren Buffett, chairman of Berkshire Hathaway and the world's second-richest man, said last week the company had a cash pile of $36 billion (€29.5 billion) for lack of investment opportunities. The last time Mr Buffett was so cautious was in 1999, just before the previous market peak.

The S&P 500 is currently trading on a multiple of reported earnings of 24 - up from 17 at the market's low point in March last year.

Valuation has returned to the level it reached at the time of the infamous speech by Alan Greenspan, chairman of the US Federal Reserve, in December 1996, warning investors of "irrational exuberance" in equity markets. The S&P 500 was then trading on a multiple of 23 but it went on to rise to 39 at the peak of the 2000 dotcom boom.

UK and European markets have not become as expensive as their US counterparts. The FTSE 100 is currently trading on a price/earnings ratio of 17, compared with 31 at its peak.

London and other European markets also dance to the tune of Wall Street and any slowdown in the US will inevitably radiate out.

Investors have taken on extremely high levels of risk in the past year. In a search for reasonably priced assets, they have increasingly been forced to look further afield - often to high-risk emerging markets. This is because pricing of many assets is being distorted by artificially low US interest rates.

US rates remain at 1 per cent - their lowest level for 40 years - while growth in US gross domestic product is running at 4-5 per cent. This has seen investors rushing to lock in returns wherever they can, often in the form of high-yielding corporate and emerging market bonds.

Yield spreads in these markets over US Treasuries contracted last year, although this has partly reversed amid the renewed caution of recent weeks.

The search for yield has also affected the currency markets, with sterling reaching 11-year highs against the dollar as UK interest rates have risen to 4 per cent.

So-called commodity currencies, such as the South African rand and Australian dollar, have seen a similar rise in value.

David Bowers, global strategist at Merrill Lynch, believes that the distortion in financial markets is affecting the economic cycle.

The willingness of Asian central banks to intervene to keep their currencies stable against the declining dollar has led to them amassing large Treasury bond holdings.

"Something really unusual is happening - the extension of cheap credit by Asia to the US," said Mr Bowers. "This has put off what would normally happen at this stage in an economic cycle. The US has not cleared its decks and repaired its balance sheet. It is very unusual to see a sustained economic recovery when the US savings ratio is so low."

Flagging US equity indices have prompted some investors to start unwinding their more risky trades.

But strategists are split on whether this marks a short-lived correction in an extended upturn of equity markets or the beginning of a prolonged downturn.

Dresdner Kleinwort Wasserstein, the most bearish investment bank in London, is advising its clients to shift into bonds in spite of that market appearing expensive to many.

Albert Edwards, chief strategist at Dresdner, says he is more bearish than ever. He expects the Nasdaq to halve and fall below 1,000 and for other markets "to break decisively below their March 2003 low".

Although more caution has crept into financial markets in recent weeks, other strategists are more sanguine.

Market performance this year has been characterised by the wide divergence of different stocks in the same sector, said Eric Lonergan, strategist at Cazenove. "Last year the rally was indiscriminate. The riskiest asset classes did the best, whereas there is enormous differentiation within given asset classes this year."

This environment favours stock-picking to find the best returns.

The bear market ended in June last year, according to Andrew Milligan, global strategist at Standard Life. "In a bear market, any rally is met with selling but last May-June, sentiment turned and people started buying on the dips."

But he is not convinced that global markets have entered a new bull phase and expects trading to continue in a narrow range - a phenomenon that has often dominated for decades. - (Financial Times Service)