Continued strength in the domestic economy points to another good year in 2005 for Irish stocks, though the pace may slow, writes Jane O'Sullivan, Markets Correspondent.

The Irish stock market weathered 2004 well, shrugging off rising oil prices and a falling dollar to rank as one of the best performers in the western world.

Helped by a strong domestic economy, the continuation of a low interest rate environment, a spectacular recovery by Elan and a solid performance from financials and a host of second-line stocks, the ISEQ was trailing only Belgium as the end of the year approached.

Even allowing for the fact that Elan shares are distinctly unlikely to repeat their near 300 per cent gain again next year, strong economic fundamentals augur well for another strong performance in 2005, analysts believe.

"Given that the general economic and financial background going into 2005 is every bit as favourable as it was going into 2004, we believe it is entirely plausible that the Irish market can repeat its 2004 performance over the next 12 months," Davy Stockbrokers noted in a recent research note.

It believes an assault on the ISEQ's all-time high of 6,447 may even be in prospect in the early part of the New Year.

Goodbody too is upbeat about the market's prospects.

"The Irish economy looks as if it will outperform all other European markets in 2005 and 2006, including the new accession states," says Mr Joe Gill, head of equity research at the stockbroker.

Assuming a continuation of a low interest rate and low inflation environment, Goodbody believes stocks with good exposure to the Irish economy, and which offer value compared to their overseas peers, should continue to outperform.

Among the broker's top picks are CRH, Independent News & Media, Eircom, IAWS and AIB, all of which have significant domestic operations. For those looking for a racier portfolio, offering both more risk and the potential of greater reward, he recommends Paddy Power, Kingspan, Ryanair and Anglo Irish Bank, all of which are highly rated but offer a higher potential growth rate.

However, Merrion Stockbrokers sounds a cautionary note, remarking that the strong performance of the ISEQ this year leaves little room for outperformance next year.

"There's no reason for the ISEQ to lag, but it won't outperform," says Merrion's Mr Rory Gillen. Nonetheless, he too remains positive about certain shares including food group IAWS, Grafton and Kingspan in the construction sector, and Paddy Power, Fyffes and Independent News & Media.

But the outlook is not without its risks, particularly in the shape of the dollar, as continued weakness will hit the many Irish companies with exposure to the US economy. Despite the strong overall performance of the Irish market in 2004, it was far from a busy year in terms of new entrants to the market.

Despite the hopes of the Irish Stock Exchange (ISE) that up to five companies would take a listing, just two eventually floated in Dublin last year, raising just over €2 billion between them. Eircom returned to the market in March, followed by drink and snacks group C&C in May.

Those departing the Exchange included radiator and plastics group Barlo, which was acquired by the Quinn Group. First Active's acquisition by Ulster Bank led to its delisting in January, while Gresham Hotel Group was sold to a consortium of private investors later in the year.

Housebuilder Abbey left the full list for London's Alternative Investment Market (AIM) and Dublin's Developing Companies Market (DCM).

The ISE, which lost eight companies in 2003 , is set to lose two more, Heiton and Warner Chilcott, if offers for both firms go through. In contrast, the queue of those planning to come to the market is not all that long.

Jefferson Smurfit Group has given a clear signal that it is contemplating a return to the market, saying it could come back within the next year and a half.

Other names that crop up regularly include the infrastructure group NTR and its alternative energy arm Airtricity, but it could be another few years before management deem that it has the necessary scale for a flotation.

Speculation continues to surround Aer Lingus although the timing, and indeed the likelihood of a flotation remain bogged down in the political process.

Smaller firms have been choosing to bypass Dublin in favour of the lower costs and lighter regulatory burden involved in listing on London's Alternative Investment Market.

In a bid to reverse this trend, the Irish Stock Exchange is examining setting up a market for small to medium-sized companies.

The impending enactment of the European Union Prospectus Directive next July, which will impose further regulation on listed companies, is also encouraging a move in this direction.

The exchange is hoping that a smaller market, modelled on AIM lines and opting for the lighter regulatory burden permitted under the new system, will attract young companies with its lower costs.

Other initiatives being considered by the exchange in a bid to boost liquidity are the introduction of a central counterparty system, which would allow stockbrokers to preserve total anonymity when trading, thereby keeping business at home that might otherwise depart to the larger London market.

It is also planning to launch an Exchange Traded Fund, based on the larger members of the ISEQ, to capitalise on the growing interest in such investments.

But at the end of the day, and as always, the key to the success of the Irish market in the year ahead lies overseas.

The performance of the US market, the shape of the euro-zone economy and the prospects for the dollar will remain crucial elements in determining the fate of Irish equities.