The first quarter of 2001 has now passed and as always financial commentators and analysts are dissecting the detailed performance of investment markets.

Although this pattern of quarterly analysis of investment returns occurs like clockwork at the end of every quarter, there is a palpable sense that the quarter just passed witnessed a seachange in investor sentiment across the spectrum of financial markets.

The declines witnessed by most stock markets during 2000 accelerated during the past quarter thus classifying the falls of many equity indices as a "bear" market. In the US the broad-based S&P 500 declined by 13 per cent during the quarter, the FTSE 100 was down 10 per cent and the Eurobloc 300 fell 11 per cent.

During the quarter, all of these indices entered official bear market territory on the basis that they had declined by more than 20 per cent from their all-time peaks. Of course compared with the Nasdaq, which declined by another 27 per cent during the quarter, the falls experienced by the more broadly based indices seem relatively modest.

Much of the debate as to whether share prices can stabilise, and ultimately recover, centres on the prospects for the US economy over the remainder of this year. There is intense debate as to whether the US recession will be shallow and shortlived, or whether it will prove to be deep and prolonged. It is likely that it will be much later this year before a clearer view emerges.

Some of those who argue for a more prolonged recession point to the apparent collapse in investment spending and future capital expenditure plans. Parallels are being drawn with Japan, where the prolonged capitalspending boom of the 1980s has left that economy with huge amounts of idle equipment and spare capacity.

This has led to a prolonged and severe deflation in Japan that seems set to continue for the foreseeable future. Although there may be some parallels between the US boom of the 1990s and the Japanese boom of the 1980s the differences are in fact far more striking.

During the 1980s, a massive price bubble was created across the entire spectrum of Japanese assets from property to share prices. Furthermore, these inflated assets funded the entire financial system so that when the bubble eventually burst the entire financial system was thrown into a crisis from which it has yet to emerge.

The contrast with the current US situation could not be greater. Although US share prices have risen sharply during the 1990s, clearly excessive valuations seem to have been largely confined to the technology sector and the 65 per cent decline of the Nasdaq from its peak level of March last year is testament to this.

Crucially, there is little evidence of speculative excesses in the US property market. Despite the increase in US household wealth generated by the equity market, property remains by far the most important asset on the household balance sheet and also the most important form of collateral for the US banking system. This suggests that the US banking system is in good shape and can comfortably weather the current economic slowdown.

A further positive feature of the US boom is that much of the growth in capital expenditure related to information technology (IT) spending. Much of IT investment has been geared to developing more efficient processes rather than capacity expansion.

Evidence of this lies in the vastly improved rate of productivity growth of the US economy compared with Europe. Furthermore, hardware IT product prices are declining systematically which of course ultimately generates extra demand.

For example, personal computer (PC) household penetration rates in the US now approach 60 per cent This may well represent saturation point for the time being. However, the relentless decline in hardware prices point to the likelihood that a $300 PC will be available in the US market in a few years. At such a low price, the household penetration rate could well rise to 90 per cent leading to a further phase of rising demand for PCs.

There now seems to be a growing consensus that the US economy is unlikely to recover from this current bout of weakness until early next year. Even if it takes somewhat longer than this, the good news is that the American financial system is in good shape, which allied with strong public finances should ensure that a period of prolonged deflation will almost certainly be avoided.