As the world economy slows we will hear less of the economic miracle in the United States
SO IS this the end of the beginning, or merely the middle of the beginning? After the dramatic events in the world stock markets over the last two weeks, it is obviously legitimate to ask whether or not the falls in share prices have yet run their course.

Much hangs on the answer to that question - we have reached the point of decision.

The 20 per cent decline in Wall Street since its peak just two months ago was, as has been argued here before, both inevitable and necessary. The market had reached dangerously high levels that were being driven by late-cycle bull market psychology, rather than by underlying fundamentals.

Reality had to out - and that has now clearly happened (vindicating at last the anxieties of the Cambridge college investors, about whom I wrote two weeks ago. At least their put option on the market should be well in the money by now).

The last few weeks have also confirmed the validity of some other well- established truths about the world's financial markets: that the proximate cause of the market correction we have seen - in this case the turmoil in Russia - is only the trigger for the more powerful underlying forces at work; and that the tone for all world markets is still largely set by what happens on Wall Street. (Note the way that even the high flying European markets have tracked Wall Street).

There, the powerful flood of new money into the stock market has not yet dried up, but the "buy on the dips" mentality which characterised the run-up in the markets last year - as mutual fund investors pumped new money back into the market every time it looked like faltering - does seem to have moderated.

All this year, we have seen a clear trend for investors putting more of their money into money market and bond funds, theoretically safer havens. In August, for the first time in some time, some of the bigger mutual fund companies found themselves facing a serious net outflow of funds.

One other piece of market wisdom - which can be summarised as "the higher they rise, the quicker they fall" - has also been amply borne out by recent events. Almost invariably, experience shows that markets fall most sharply immediately after they have risen most sharply.

What is distinctly unusual about this market correction, however, is that it has been so widely predicted. Unlike many previous sharp falls in the stock markets, this one cannot be said to have come out of a clear blue sky. I have lost count of the many reasoned and unanswerable demonstrations of risk inherent in market prices - starting with Alan Greenspan's mutterings about "irrational exuberance" more than 18 months ago.

So where do we go next? The markets, in broad terms, have now given up all of the gains that they have made since the start of this year, but they have not yet fallen back to the levels that first caused Mr Greenspan such concern - which was the level prevailing at the start of 1997. Will they go back all the way to that level?

As usual, this is a judgement call to which no definitive answer can be given. To the extent that sentiment is still driving the markets, the prospect is not so good. The Russian crisis is clearly a long way from resolution, although its impact in economic terms is nothing like as important as its perceived impact and political resonance. (The Russian economy is contracting so fast that it ranks as only a minor player).

My guess, for what it is worth, is that the latest crisis, coming on the heels of the much more serious (economically) events in the Far East, will finally be enough to puncture the bull market case. As the world economy starts to slow, as seems to be regarded as inevitable by most pundits, then we will stop hearing so much about the economic miracle in the United States.

Attention will once more focus on the actual profitability of companies, and this in turn will lead to further downrating in p/e ratios. It is true that the market is still being underpinned by falling interest rates. Long bond yields are now at their lowest level in a generation - nudging 5 per cent - but the driving force is now slowing economic activity rather than a perceived decline in risk. In fact, the evidence from around the world is of a clear flight to quality. Look at how rapidly the risk premia on instruments such as corporate bonds and emerging market debt have widened.

These are still early days, of course, but the market certainly feels like it is ripe for further purging. There is a clear risk - say 40 per cent - that we may yet touch the levels the markets were at 18 months ago. It is hard to give the prospect of a renewed bull market regaining all the lost ground more than a 20 per cent chance. Something in between, perhaps a sideways drift with continued patches of volatility, seems the most likely.

As ever, the sensible thing to do is keep an eye out for value opportunities. With oil prices and commodities generally in a clear cyclical downturn, the time to find some value in those markets will probably come sooner than it does for the market as a whole. While emerging markets seem intent on regaining their former basket case status, at some point there will be some value to be found there for the risk-seeker. Those who like to follow investment trust discounts will be keeping a close eye on how wide the discounts go.

A bargain is a bargain, whatever the prevailing climate. The time to make the most money in the stock market is when pessimism is at its height and the headlines are full of gloom and doom. The Greater Fool Theory - which guides unwise investors into buying overvalued stocks on the grounds that they will always find someone more unwise to buy it off them - is never so evident as when markets reach the levels they did a year ago.

But my hunch is that the supply of greater fools is now on the wane, and that suggests it would be wrong to expect too much of a rally too soon.