The past year has been a truly dismal one for the Irish stock market, with the ISEQ Overall Index down more than 15 per cent from its high point of last March.
Financial shares, in particular, have taken a pummeling on fears over the direction of interest rates. Analysts with the major Irish broking houses are united in the view that international markets will not rebound until another rise in US interest rates - now almost certain for the Fed's November 15/16th meeting - brings a slowdown in US economic growth and a consequent stabilisation in US government bond yields.
NCB's head of equity research, Mr John Reynolds, believes firmly that US bond yields - effectively long-term interest rates - are the key factor in the recovery of stock markets. In a recent report he stated that "the sogginess of the bond market is exerting a negative influence on equity markets and the value of the Irish stock market is unlikely to be released until bond yields peak. That seems unlikely before year-end."
"We need to see evidence of a slowdown in US economic growth before bond yields ease and we are still some way from that. The American consumer is still reluctant to lie down and interest rates will have to rise again before he stops buying," Mr Reynolds said.
Stocks are under pressure from bonds but the NCB analyst believes that US bond yields should peak before the end of the year, allowing for an improvement in equity prices in the first quarter of 2000 - traditionally the strongest quarter of the year for equities.
"By then, we should see a renewed focus on earnings growth and on that basis Ireland looks good with forecast 18 per cent earnings growth next year," he said, adding that once markets rebound the Irish market may outperform international markets.
This would reverse the trend in recent months when the fall in the value of the Irish market has been far greater than other markets. "We will probably see some outperformance on the way up, once interest rates settle the Irish market should do well given that over 30 per cent of the index is made up of financial shares," Mr Reynolds stated.
"There are grounds for optimism but a lot of questions need to be answered before one could go back into equities with any confidence," he said, adding that "any significant increase in the US trade gap as a result of outflows of capital could put pressure on bond yields."
Mr Reynolds said that domestic factors such as the movement of investment funds from Irish stocks to the euro zone "are played out to a large degree" with most fund managers already in their 20/25 per cent preferred allocation for Irish equities.
He also believes that the fears among some international investors about the sustainability of the Irish economic boom are likely to be assuaged next year.
"The proof will be in the eating. The Irish economy should show 67 per cent growth with corporate earnings growth of 18 per cent and benign inflation. That's an attractive cocktail for any investor."
Of all the Irish market strategists, Goodbody's Liam Igoe is far and away the most bullish about the prospects for the market, although he believes that his ISEQ target of 6000 for the end of the year may now take until the end of the first quarter of next year to achieve. Even that target seems ambitious to many in the market, indicating a 30 per cent recovery in share prices from their current levels.
Like other analysts, Mr Igoe believes that US inflation and interest rates are the key to the recovery. "We'll probably see US growth taper off next year from 4 per cent to less than 3 per cent and an easing in inflationary pressures," said Mr Igoe, who drew some reassurance from last Tuesday's relatively benign US inflation figures.
"American interest rates will probably go up a quarter-point but that will only bring them back to the level there were at before the Asian crisis. The only surprise is that the Fed has been so slow to raise rates. We should see some improvement in bonds, and although p/es are high the prospect for earnings growth are good. Europe is coming back into focus as a growth area and with greater investor interest in Europe some crumbs might fall our way," said Mr Igoe.
"If the American market can move again even modestly then the Irish market should outperform in the recovery period. "We've had very substantial falls from their highs by the leaders - Irish financial shares are 30 per cent off their peak - but I think that the market has bottomed out at these levels." said Mr Igoe.
ABN-Amro economist Dan McLaughlin believes that the environment for equities is mixed. "We're seeing growth picking up substantially in Asia and as a consequence European economic growth is being revised from 2 per cent to 2.8 per cent next year. All this is positive for corporate earnings. But that has to be offset by the likely rises in interest rates in the US, the UK and the euro zone and the rise in bond yields," he said.
Financial shares have been the weakest section of the Irish market and Davy analyst Mr Robbie Kelleher believes that the big decision is whether the financial shares can regain some of their 30 per cent underperformance relative to the industrials.
"Irish financials now trade at rock bottom valuations in a European context. Yet the trading environment is likely to remain favourable for several years," says Mr Kelleher.
He adds, however, that if the technical factors affecting the market - asset reallocation and concern among international investors over the pace of the economy - diminish as he expects them to, then the financials should rebound relative to the rest of the market.
Of individual financial shares, Davy prefers Bank of Ireland and Irish Life & Permanent, while among the industrials, the broker believes that Smurfit should benefit from the strengthening global economy.
Of most significance to Irish small investors is the direction of Eircom shares, and here analysts believe that the share is unlikely to make much headway from its current trading range between €3.90 and €4.10. The belief that Telianor - the merged Telenor-Telia - will sell its 14 per cent of Eircom will restrain growth in the share price, while another negative factor is the current weaker sentiment in the markets towards telecom stocks in general.
"Eircom shareholders should settle in for the long haul, they're unlikely to get much joy over the next year," said one Dublin dealer.
