Clouds have been rolling through Denmark in 1998, and the silver lining looks like it has been deferred until at least next year.

Although the economy is still in fair overall shape after five boom years, the stock market performed in the bottom range in the Nordic region. The all-share index declined by 9% in the first ten months, while the KFX fell by 3%. Several leading Danish companies - including some in the rock-steady food and beverages and pharmaceuticals sectors - issued profit warnings or downgraded expectations. The balance of payments lurched into deficit for the first time since 1989, and wage rises topping 4.8% for the third quarter prompted fears of overheating.

The best that most market observers can hope for, in the mid-term, is a reduction in interest rates and an easing of monetary policy.

We've been caught by two waves," says Carl Jensen, head of equity research in Aros Securities Copenhagen. "Trading suffered a monumental setback in the first half of the year due to domestic uncertainties - including a general election (in which a Social Democrat-led government was narrowly returned to power), a strike by public-sector workers, the referendum on the Amsterdam Treaty and speculation about the fiscal impact of this year's budget. Then, just as the situation looked to be recovering, foreign factors kicked in."

External investors have been the net buyers of Danish equities in recent years while local investors diversified overseas. However, foreign investors dumped shares worth DKr4bn ($600m) up to September as part of the global unloading process, and seem to be weighing their options carefully before returning.

"Nordic markets were more exposed than most in the recent flight of international capital," says Tommy Erixon, chief Nordic analyst with the Carnegie group in London. "But Danish equities have traditionally been regarded as a safe haven in the region. They caused a surprise in performing so de-plorably, and the reversal of relative valuations with Sweden - which has lots of cyclicals include engineering, pulp and paper and metals - is particularly hard to explain."

One reason seems to be simply that other parts of the region have been proving more attractive. "Finland has crystallised as the favourite market," says Erixon. "It has got better macroeconomic prospects - and a forecast GDP growth 3.5% next year - there is no currency risk because it is the only Nordic country signing up for the first phase of euro and more companies there offer long term growth, such as Nokia and Sonera."

There are, however, already signs that Danish institutions are being tempted back into the local market place and helping to restore balance. "Previously local institutions had a limit of 35-40% on their percentage of equities of total funds," points out Jensen. "That limit was raised to 50% in June, which leaves a lot more net room for buying equities."

"Valuations are becoming much more realistic and that is bound to revive foreign interest," notes Erixon, although he thinks that pro-cess could be speeded up if big Danish companies went for more disclosure, including quarterly rather than half-yearly reports. "In general, Denmark has the GARP factor (growth at reasonable prices), which will always be attractive on the back of the stable growth profile of the services, food and beverage and telecoms sectors. We see manufacturing recession, but not outright recession."

Bank stocks are relatively inexpensive, in his view, given their limited exposure to hedge funds and emerging markets, and their retail strengths. He mentions the strong restructuring and consolidation theme at play in the Nordic region. Other areas tipped by analysts include the service sector.

"There's less tension now in the market. It's extremely quiet and liquidity has dried-up to a greater extent than at other year-ends," notes Henrik Asmussen of Ny-kredit. "The key is whether austerity measures that take effect on January will succeed in slowing down private consumption. The markets will want to see firm signs of that as we move into the first quarter 1999."

Unibank Markets' chief analyst Jakob Vejlø is optimistic that the government has done enough to take the heat out of the economy.

"A progressive decrease in the very high interest rate relief on housing loans - from 46-32% over the next three years - will dampen private consumption, as will in-creases in petrol prices. We expect the current account deficit to fall back to about DKr3-4bn and GDP growth to come in at about 1.8% in 1999."

Moderation in December's public sector wage negotiations and the finalisation of a reduction in corporate tax will probably help to stabilise the market, in his view.

The krone came under heavy pressure in the summer, but that has now eased after heavy central bank intervention. An agreement with the European Central Bank setting fluctuation zones of 2.25% around the euro should be effective in stabilising the currency. "We expect monetary policy to continue to ease, and the repo rate to settle at about half a point above the ECB rate, giving a target of 3.75%," says Vejlø. That in turn will feed through into the bond market, which has been of major interest to foreign investors in recent years. They now account for about 9% of total Danish mortgage bonds, and Vejlø sees that trend continuing.

"We see plenty of room for the spread between the Danish and German 10-year spread narrowing, with a target of 25%." Carnegie ex-pects the spread of 55 basis points to the German long-bond yield to reduce to 40 over the next 12 months. The only major caveat is the high percentage of government bonds held by foreigners - about DKr300 bn, equivalent to 30% of GDP. Any sellback could force the central bank to raise the repo rate again, but the downward trend in global yields is making that less likely.

"Denmark is not our preferred Nordic market - not while you have stars such as Finland shooting away," sums up Erixon. "But it is respected, and will retain a middle of the road picture." Margaret Dolley"