Investor/An insider's guide to the market: For many financial analysts, the most important variable affecting securities' prices is the interest rate - especially the interest rate on long-term government bonds.

The capital value of long-term assets such as company shares depends on the ability of the respective companies to generate a stream of revenue into the future. The share price of a company reflects the cumulative value today of this expected future revenue stream.

If interest rates go down, the value today of this stream of revenue goes up, implying higher share prices. Conversely, if interest rates go up share prices generally fall, other things being equal.

Of course, other things are rarely equal and changes in interest rates have not been the main determinant of equity market performance in recent years. Indeed, short- and long-term interest rates have either been declining or stable for several years. Therefore, changes in interest rates have not been an important factor underlying the 2000-2002 equity bear market and the subsequent partial recovery in 2003.

Changes in corporate profits and, more importantly, changes in expectations regarding future growth rates in such profits has possibly been the key determinant of equity market performance over the recent past.

In the US market, corporate profits declined by close to 20 per cent in 2001 and, not surprisingly, this led to a sharp sell-off in equities.

As well as the actual fall in profitability, there was also a major reassessment of the quality of company profits due to the apparent proliferation of dubious accounting practices. There were many high-profile instances where company managements effectively "cooked the books". Profits at companies such as Enron and Lucent Technologies, to name only two, turned out to be more fiction than fact.

This led to a crisis of confidence in corporate America and to a downgrading of expectations regarding corporate US's ability to generate genuine long-term growth in profits. In this environment, it is not too surprising that a modest recovery in profitability during 2002 failed to prevent further sharp falls in share prices.

However, on the back of a better US economy in 2003, company profitability has continued to improve. In addition, corporations are beginning to adopt a more conservative approach to their accounting policies, largely due to external pressure from regulators and investors. Costs associated with pension fund liabilities and the granting of share options have now begun to be taken more fully into account.

This has given investors greater confidence in the quality of reported earnings. Over the first half of this year, US corporate earnings have grown by approximately 10 per cent compared with the first half of last year.

We are currently in the midst of the third-quarter reporting season and equity analysts are confidently predicting that Standard & Poor's 500 companies will report aggregate profits growth in the 15-20 per cent range. Motorola was one of the first companies to report third-quarter results. Although profits were flat compared with a year ago, they were much better than expectations and the company signalled that the fourth quarter was looking good.

In general technology stocks are expected to post year-on-year earnings growth in excess of 20 per cent in both the third and fourth quarters. Given the very sharp rise of over 40 per cent in the technology-laden Nasdaq index so far this year, such rises in profits are essential if technology stocks are to build on the dramatic price gains since the market bottomed in March of this year.

The financial sector is another sector of the US market that is expected to perform well where profits are also expected to grow by over 20 per cent compared with last year. M&T Bank in which AIB holds a 22.5 per cent stake, recently reported a good set of third-quarter results. Earnings per share rose by 20 per cent, driven mainly by cost reductions, and the bank stated that it was optimistic regarding the full-year outturn.

For the US market as a whole corporate earnings now seem set to rise by approximately 15 per cent in 2003 compared with 2002.

If the US economy maintains its growth momentum going into 2004, then corporate profits are certain to rise further. With the Federal Reserve committed to maintaining a low interest rate regime, better profitability would act to underpin the US equity market.

In the absence of an extraneous shock the progress of equity indices both in the US and elsewhere are likely to be even more sensitive than usual to the picture that emerges regarding company profitability between now and year-end.