As the gloom deepens, investors ask: Is this the death of the cult of equities?

The market is off a third from its peak, floats are sinking, money is pouring into bonds

These are dark days for the stock market. The FTSE 100 index is down by exactly a third since its peak on the last day of 1999. Large flotations such as Focus Wickes and Yell are being pulled due to lack of institutional appetite. And cash is moving relentlessly into safer investments such as bonds and cash. Other "safe haven" asset classes, such as property and even gold, have been soaring too.

As the market gloom continues to deepen, an ugly question raises its head: are we looking at the death of the cult of equities?

The so-called cult of equities dates back to the late 1940s when senior investment managers started to move away from government stock, or gilts, as they returned a poor yield that was a fraction of the level of inflation. Shares were yielding much more at the time and the money men figured they offered better scope for growth too.

One of the key champions of the move into shares was George Ross Goobey, a fund manager at Imperial Tobacco, and the father of Alastair Ross Goobey, the former chief executive of Hermes Asset Management. Mr Ross Goobey Snr, who died in 1999, was appointed the first in-house actuary to the Imperial Tobacco fund in 1947 and advised a 100 per cent exposure to equities. He gradually built up a portfolio of more than 1,000 stocks and became known as the "archdeacon of the equity cult". Other institutions started to follow his lead and share prices rose accordingly.

Things are very different now. The total return on UK equities has fallen 14.8 per cent in the past 12 months. That compares with a rise of 7 per cent in bonds and 4.4 per cent in humble cash. Equities fell 8.4 per cent in June alone, the worst month since September 2001.

The yield gap, which is the yield on equities minus the yield on bonds, also tells a story. It now stands at minus 1.92 per cent, the lowest for 35 years. This indicates that investment managers do not believe that the high yield available on shares is worth the risk given the recent accounting scandals and the lack of visibility about future earnings.

They are piling into the safety of bonds instead. Indeed bonds now account for 14 per cent of UK pension fund holdings compared with just 4 per cent in 1990. SG Securities forecasts this will rise to 20 per cent in the next three to five years as pension funds seek a more reliable method of meeting their liabilities.

The bank also points out that in the US the number of directors selling shares outweighs the number buying them by four to one. This hardly fills other investors with optimism.

Predicting the death of the cult of equities might seem an extreme position. But the view does have its supporters. One is Steve Russell, equity strategist at HSBC. "The cult of the equity has died and we are probably getting closer to the period where the excessive hopes are priced out of the market," he says. "Normally the current yield gap would be a strong buy signal but we believe it will only underpin equity valuations around current low levels. Our view is that equity markets will hit new lows in the next three to four months and then start to rebound but only to lower levels of return."

It is not surprising that Alastair Ross Goobey, now a consultant at Morgan Stanley Dean Witter, disagrees. He says: "You could go back to the 1970s and find that people were making the same prediction about the death of the cult of the equity. There was, perhaps, more justification for that view then, since we had a government that was overly hostile to business, and price controls. My view is that these are simply medium-term swings in sentiment, and that, in due course, equities will reach a level of valuation that will ensure their revival as a preferred asset class.... These things take time, but they don't mean that the basic laws of investment have been destroyed."

John Hatherly, head of research at the fund management group M&G, also believes that history is on equities' side. "You hear the word 'capitulation' with the depth of pessimism forcing people to give up and throw in the towel. But when people start to talk about death of the cult of equities I would take that as a very strong 'buy' signal," he said.

He points to strong areas of the market such as the tobacco sector, which is up 28 per cent on the year with real estate up 10 per cent. Some individual stocks have done particularly well. Stanley Leisure, for example, has outperformed the FTSE All Share index by 63 per cent in the year to date, while there have been outperformances of 40 per cent plus by Balfour Beatty, Carillion, Imperial Tobacco, New Look and Arcadia. "In a real bear market," Mr Hatherly says, "everything goes down."

Mr Hatherly's view is that the US consumer economy is quite robust, adding that the Federal Reserve is "very aware" of the importance of the stock market and that "there is a chance that it will cut rates later this year".

Bob Semple at Deutsche Bank is also more sanguine after a bearish stance last autumn. "I would have said that the pendulum has swung too far from over-optimism to over-pessimism and will start to go the other way now," he said.

However, he predicts that once equities start to outperform bonds again, the pendulum will swing back once more.

The next few weeks could prove crucial. From the middle of this month major US corporations will start reporting their second-quarter figures. Any profit warnings or overly negative guidance on the outlook could trigger a fresh slide in markets.

Mr Hatherly at M&G points out that the key psychological level of the FTSE 100 could be the 4,433-points close of 21 September, when markets hit their post-terrorist attacks low. "If we get something bad that pushed us below that, people will start to talk about a prolonged bear market and pondering how much lower it can go," he said.

Where do the experts suggest smaller investors put their money? Not in residential housing, they say. The market is overheated. Not in gold either, they caution, as it has already enjoyed a strong run and produces no return in the form of dividend income.

Senior fund managers suggest a portfolio that includes a mix of income stocks and bonds plus some exposure to commercial property. For the ultra-cautious, you could do worse than putting your money in a high interest building society account, which could pay around 4 per cent a year. Some may even favour sticking it under the mattress.

But things aren't really that bad. Are they?