The year has gotten off to a rocky start for the US stock market, with major indices down sharply year-to-date. And, the biggest falls have occurred in technology and small-caps.

So it appears that after overlooking looming risk factors in the fourth quarter, investors are having second thoughts about the outlook. But sentiment may not remain consistently negative and, going forward, there is the likelihood of many upswings and downswings in the stock market.

As we mentioned previously, there is a growth slowdown in the works for the US economy.

Policy stimulus, which had been a big factor in juicing up economic performance in the past, has been withdrawn. The Fed is in tightening mode, and while it is going to proceed in baby steps, any signs of strength in the economy will likely elicit another turn of the monetary screw.

As for earnings growth, after a good performance in 2004, it should slow down substantially this year. The current consensus expectation is for S&P 500 companies to clock in 10.5 percent earnings growth in 2005.

This estimate appears to be too optimistic, given the headwinds, and is likely to be revised lower as the year progresses. What we?ll get is deceleration of profits as the economy loses momentum

Essentially, the US is the main engine of growth for the world economy. There is not much domestically-generated power in Europe and Japan to lead global activity while, in Beijing, authorities are applying the brakes to the Chinese economic express to prevent it careening out of control. If there is a slip-up in US growth, the repercussions will be felt globally.

The biggest danger to a modest upside for stocks in the United States is the Fed interest rate cycle. If policymakers become more aggressive in fighting incipient inflation, then equity valuations will be hurt as a consequence. We could get a nasty case of multiples being compressed, as investors choose to pay less generously for prospective earnings.

Stocks are cheap relative to bonds because bonds are still expensive in historical terms. The Fed, aided by Asian central banks, was instrumental in generating this happy state of affairs but is now in the process of gradually normalising interest rates. Needless to say, higher interest rates diminish the comparative attractiveness of stocks.

Decelerating earnings growth and rising interest rates are likely to encourage a flight to quality. Firms with higher credit ratings, healthy finances and stable earnings will be favoured at the expense of those with dodgier specifications.

Notably, many of the quality names are in the large-cap category. So it didn?t come as a surprise that in the sell-off during the first week of January, small-cap indices registered some of the steepest declines.

Another category that suffers badly in a deteriorating profits cycle is technology. An analysis of the sector reveals that productive capacity has increased ahead of demand, valuations are on the rich side and pricing power is relatively weak. There is the presumed promise of rapid growth but little cash is actually returned to shareholders. The sector is vulnerable if we get disappointing news.

Base metal prices have experienced a correction year-to-date. This is not unrelated to the rally in the US dollar and it is too early to say if it is the beginning of a significant downward correction. There are still a lot of investors who are betting on a multi-year boom in commodities, based largely on China?s growth prospects.

In the past few months, sharp falls in the LME?s (London Metal Exchange) metals index have been followed by a rebound. Speculative long positions in commodities are still substantial and any unwinding will depend on how the China slowdown story plays out.

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Iraj Pouyandeh is a Strategist and Senior Portfolio Manager at LOM Asset Management and manages the LOM Equity Growth Fund. For more information on LOM?s mutual funds please visit www.lomam.com.