In recent weeks there have been signs the optimism that has abounded regarding economic recovery is weakening.

For investment markets, the first quarter of 2002 was eventful in terms of newsflow and market action. At an overall level, share prices gave the impression of marking time, with the major stock market indices producing either small positive or small negative returns.

However, this apparent stability in the market indices disguised the extent of share price volatility over the quarter. A feature of many stock markets during the quarter was that sharp declines in the share prices of a small number of very large companies tended to drag the overall indices lower.

For example, the FTSE 100 eked out a small gain over the first quarter. However, the index's largest constituent, Vodafone, fell by 28 per cent, which knocked 150 points off the index. If the share price performance of Vodafone was stripped out, the FTSE would have risen by approximately 4 per cent in the first quarter.

Closer to home, Elan's impact on the ISEQ was even more dramatic. Taken at face value, the sharp decline in the ISEQ indicated that Irish-quoted shares produced the worst return in Europe over the January-March 2002 period. If Elan is excluded from the calculations, the ISEQ becomes one of the top-performing indices in Europe.

The telecom and pharmaceutical sectors of most markets tend to account for a high proportion of the total market capitalisation of those markets. These companies tend to be large global enterprises and, therefore, they loom large in most diversified equity portfolios. Analysis of share price movements over the first quarter, excluding the small number of high-profile casualties, shows that many companies enjoyed positive share price gains during that period.

The backdrop to this more positive environment was the flow of economic data in the US, which showed that the 2001 recession was in fact extremely shallow, and that an economic recovery had already begun in the first few months of 2002. The Federal Reserve consequently changed its monetary stance to a neutral bias, signalling that the next move in US interest rates will be upward.

However, in recent weeks there are signs of some slippage in the degree of optimism attached to expectations regarding economic recovery. Tension in the Middle East and the rising oil price have served to dampen expectations somewhat.

An additional factor is that inventories were run down sharply in the fourth quarter of 2001, particularly in the US. There is a feeling that a significant portion of current US economic strength reflects the rebuilding of abnormally low inventory levels. Once this process is complete, economic growth could well slow considerably.

Two other factors are causing analysts to be cautious about the strength of the current pace of US economic growth. Firstly, consumer demand never really weakened during the recession and there is little scope for it to grow rapidly from current levels. Secondly, capital spending as yet shows little sign of staging a rebound.

Statements from the giants of the computer industry, such as Dell and IBM, point to a stabilisation in market conditions. Most companies in the telecom and tech sectors continue to predict it will be 2003 before demand for their products and services resumes a strong growth trajectory.

As if to confirm this element of uncertainty surrounding economic recovery, the monetary authorities in the US, Britain and Europe seem to be adopting a wait-and- see attitude before making any interest rate moves. The case for a rise in short-term interest rates is strongest in the US, where three-month interest rates are still well below 2 per cent (see table). Interest rates are considerably higher in Britain and the euro zone.

A feature of particular note is that 10-year bond yields are now at exactly the same levels in the US, Britain and the euro zone and are considerably higher than short-term interest rates. Bond yields have risen by about 25 basis points (0.25 per cent) over the past three to four months in response to improving economic conditions and increased government borrowing requirements.

Therefore, the gap between short-term and long-term rates has widened, particularly in the US where 10-year bond yields are nearly 3.5 per cent points higher than short rates. Such a gap is generally viewed as indicating that the stance of monetary policy is very stimulative.

The fact that the US Federal Reserve has been so slow to adjust its monetary stance suggests it still views the economic recovery as being fragile. An environment of moderate economic growth and generally low interest rates still seems to be the most likely outcome for the remainder of 2002.