The prospect of moderate investment returns has persuaded some corporations that cash dividends could be the future.

Talk of possible war with Iraq is likely to remain the dominant macro force affecting sentiment on global stock markets for some time.

The increase in geopolitical tensions is clearly the main reason for the rise in the price of oil in recent months. The rise in the price of gold to more than $350 (€328) an ounce can probably be at least partly explained by the uncertainty engendered by developments in the Middle East.

Some analysts are also blaming the Iraqi crisis for the sharp recent fall in the dollar to a rate of €1.06.

While the potential conflict in the Middle East is negative for the dollar, its continuing decline is being primarily driven by the economic fundamentals. In particular, the enormous US trade deficit has for long been sending a clear signal that the US dollar is fundamentally overvalued.

Equity markets have also remained volatile and have recently given back some of the price gains achieved in the early days of the new year.

US equity markets are still in positive territory although UK equities are languishing with negative year-to-date returns.

No clear trend has yet emerged, although it would seem that equity markets are reacting to fresh economic news in a predictable fashion rather than being unduly buffeted by worries over the Middle Eastern conflict.

The economic picture that is emerging from these data releases is one of slow growth, mainly due to continuing weakness in corporate investment. Consumer demand is holding up but most forecasters believe that high levels of personal debt will increasingly act as a drag on private consumption.

In this scenario, interest rates in the UK and continental Europe seem set to decline further during the first half of 2003.

In the US, the Federal Reserve is likely to leave short-term interest rates on hold at 40-year lows for most of the year.

A satisfactory resolution of the Iraqi crisis, combined with clear signs of robust growth in the US economy are probably twin preconditions for any change in the Fed's current policy stance. Therefore, in the absence of some positive economic surprises, probably the best that equity investors can hope for in 2003 is modest capital appreciation in the 5-10 per cent range.

One sign that some powerful corporations are recognising that moderate investment returns will be the medium-term norm comes from Microsoft, which says it would start paying a cash dividend.

Microsoft has accumulated an enormous cash reserve and, up to now, has resisted calls to pay some of these reserves out to shareholders in the form of dividends. The company's rationale is that, in the long run, shareholders will achieve higher returns from the reinvestment of cash in the technology business.

For most of the past two decades this has unequivocally been the right policy. By reinvesting surplus cash in innovative products, Microsoft has been able to sustain impressive growth in revenues and profits.

However, its decision to pay a dividend does seem to send a clear signal that it expects the flow of new profitable investment opportunities to slow down in coming years.

Microsoft's decision to inaugurate dividend payments has probably also been a function of a mooted change in the taxation of dividends in the US.

The current tax code in the US militates against the paying of dividends. This is because dividends are paid out of after-tax corporate profits. They are then subject to income tax in the hands of investors at the individual's normal rate of income tax.

In this sense, dividends are taxed twice - at corporate level and at the individual investors' level. This tax regime has been a key factor explaining the fall in the number of US companies that pay cash dividends.

The Bush administration is proposing to abolish the individual's tax liability on dividend receipts. A strong argument in favour of this change is that it should, over time, encourage companies to pay out a higher proportion of their earnings to shareholders in the form of cash dividends.

In theory, this should lead to a more efficient allocation of capital across the economy. This is because companies will only hold onto profits if they can find investment opportunities that will produce high returns. If not, they will pay profits out in the form of dividends, particularly if there is a level playing field in the relative tax treatment of dividends and capital gains.

Investors will then be free to reinvest the higher overall level of dividend payments and, in doing so, they should reallocate capital to those sectors that have relatively attractive investment opportunities.

Microsoft's dividend announcement and the expected change in the US tax treatment of dividend income are two further signals that dividend payments in coming years could well become a larger component of shareholder return than capital gains.