Uncertain global outlook and the threat of war continue to unsettle markets but on closer inspection the news is not that bad

For the financial markets July and August are traditionally the quietest period of the year. The summer lull in 2002 was characterised by continued weakness in equity prices although there were some tentative signs of nascent recovery towards end August.

However, the Cassandras were quick to point out that September has historically been the worst-performing month for equity markets by a significant margin. How right they have proved to be as the world's stock market indices plunged further during the month.

Share prices as measured by indices such as Britain's FTSE 100 and the US Standard & Poor's 500 are now back to price levels that prevailed as far back as 1996. The situation regarding Irish share prices is not quite so bad with the ISEQ index now trading at 1998 levels.

The pervasive weakness in share prices in September has resulted in a third-quarter equity market decline that was even greater than the very poor second quarter, the worst since the crash of 1987. Major indices such as FTSE 100 and S&P 500 declined by about 20 per cent in the quarter with Germany's DAX index down by 36 per cent.

Uncertain prospects for the global economy combined with the threat of war in Iraq continues to unsettle investors in all markets.

However, on closer analysis the prospects for the global economy are in fact not particularly bad, rather it is just that much of the economic news has been somewhat disappointing. For example, forecasts of economic growth in Europe have been scaled back to less than 1 per cent from earlier expectations of 2 per cent growth.

In the US there are intensifying worries that a slowdown in private consumption is imminent. However, as yet the actual evidence is that US consumers are continuing to spend.

Therefore, it is economic uncertainty that seems to be the main culprit rather than really poor economic news. With low interest rates and expansionary fiscal policies in place across the globe there is still a very good chance that the global economy will avoid the feared double-dip recession.

An examination of news related to particular sectors and companies sheds more light on the factors that have driven share prices down to recent lows.

For example, insurance stocks have continued to fall due to ongoing weakness in their capital positions. The cumulative drop in share prices in recent years has decimated the capital position of many companies. This has forced some companies to sell equities to reduce the volatility of their assets, which has in turn acted to put more downward pressure on share prices creating a self-feeding cycle of falling equity prices.

At this stage some insurance companies such as the troubled Equitable Life have sold virtually all of their equity holdings in their main investment fund.

The weakness in the insurance sector spilt over to the banking sector during September. Many banks will now be forced to inject fresh capital into their insurance subsidiaries. Also, if economic conditions do deteriorate significantly then bank profitability will be hit by an increasing incidence of bad debts.

In this generally gloomy environment the two main Irish banking stocks have brought a little recent cheer to their investors.

Bank of Ireland updated the market on its business outlook in an interim pre-close trading statement. The bank is enjoying continued growth across all of its divisions with the exception of asset management and bancassurance. However, in these segments the bank is performing far better than its peers and growth in new business is offsetting any declines due to general equity market weakness. The core banking business in Ireland and the UK is performing strongly with good growth in lending volumes despite lower levels of economic growth.

The news from Bank of Ireland was, however, trumped by its archrival. AIB announced the effective disposal of its Allfirst subsidiary through a merger with New York based M&T Bank. AIB will receive $886 million (€898 million) for Allfirst together with a 22.5 per cent stake in the combined entity.

While AIB will have board representation, the combined entity will be run by M&T management. AIB's stated intention is to retain its investment in the long-term, although the experience of such structures is that the minority stakeholder eventually sells out.

The deal does have unambiguous positive implications for AIB. It effectively draws a line under the Rusnak affair and will free AIB's management to concentrate on the bank's core businesses. At a financial level AIB's capital position will be strengthened which will give the bank greater capacity to grow its remaining businesses.

AIB also announced that on completion of the deal it will buy back approximately $450 million of its own shares.

Finally, at the overall market level the deal should inject some confidence as it shows that corporate managements are still capable of pulling off large-scale deals even in the current volatile and uncertain financial climate.