For the past three years the New Zealand share market has been delivering stellar returns, with the gross index returning in excess of 20 per cent in 2003 and in 2004.

Moreover, since the global share market bubble burst in early 2000 the New Zealand market has been one of the best-performing markets in the world.

To some extent this performance was long overdue, given that the New Zealand market had been totally left behind in the manic period of the late 90s. Nonetheless the past few years have been rewarding for local investors. What's more, it appears that this performance has been more than deserved and totally justified.

If economic fundamentals have anything to do with the movement of share markets, then the New Zealand market clearly deserves to have been a good, and possibly a great, performer over the past few years.

Over that time the New Zealand economy has been in something of a purple patch, or "sweet spot" as some commentators have put it. New Zealand has enjoyed one of its longest post-war economic expansions, and this has certainly been helped by the strength in our agricultural prices and the general boom in global commodity prices. Given this backdrop it therefore seems sensible, and possibly obvious, that the New Zealand market should have delivered outstanding absolute and relative returns.

Unfortunately, even over periods as long as several years, a direct causal relationship does not exist between a country's share market and its economy.

That something other than economic fundamentals drives markets, even over quite lengthy periods, is shown by the graph, which charts the New Zealand gross index (the blue line) and the Austrian gross index (the grey line).

Both returns have been rebased to allow easy comparison, and both have been converted to a common currency, the US dollar. The similarity between the two lines is apparent. Both moved generally sideways until about mid 2002, and then both began to rise dramatically over the past three years. The magnitude of this rise has been remarkably similar, but so too have the individual monthly movements of each market. Generally when one market has risen in a month so has the other and vice versa. The correlation between the markets when looked at in a common currency has been 98 per cent. The Austrian share market and the New Zealand share market, from the perspective of an international investor looking at the two markets in his own currency, have been Siamese twins for almost six years.

What could have caused these two markets, on opposite sides of the world, to move in such lock step?

If the New Zealand market has been responding to its own economic boom, then what's been driving Austria? There are almost no similarities between the New Zealand economy and that of Austria, and the make-up of the two share markets is quite different too, with the Austrian market being dominated by banks and financial institutions. However, one common feature is found in the two markets: size.

The New Zealand and Austrian markets are small in a global scale, with both representing substantially less than 1 per cent of the total world share market, and the average company on either market would be considered small in a global context.

When the global share market bubble burst five years ago, sophisticated investors, first in the US market and then globally, began to focus on what had been largely overlooked smaller companies. It was apparent that smaller company shares had been left behind in the bubble years, and those shares were far cheaper, with better growth prospects, than larger companies. Initially these smaller, left-behind issues didn't fall anything like the over-inflated larger companies. When the dust had settled on the bear market in early 2003, smaller companies were off to the races. International investors didn't care whether those small companies were in the United States or Great Britain, or even Austria or New Zealand; they just wanted to buy good value with good growth prospects.

Over the next two and a half years smaller companies dramatically outperformed larger companies, and smaller markets generally did better than larger markets. Clearly this is something of an oversimplification and local factors do have an impact on markets, but at the margin, and it is a fairly large margin, global trends in focussing on large or small companies and growth or value companies also can have a very profound effect on markets.

It is quite possible that it is this effect, at the margin, that has caused New Zealand and Austria to perform to such a similar beat, despite quite different local factors.

Unfortunately all tides eventually turn, and small value was never going to be the global flavour of the month for ever. Five years ago the New Zealand market was cheap versus the rest of the world; now it is about as expensive as it ever gets. Equally, five years ago small value companies were cheap versus large growth companies. After five years of out performance this is no longer the case. When the global trend in favour of smaller issues turns, and there are some signs that this may already be happening, the marginal effect that has delivered such a tailwind to New Zealand and Austria will turn into a headwind.

Even if the New Zealand economy continues to do well it is quite possible that some of our global out performance of the past few years may be given back for reasons totally beyond our control. If this happens it may be perplexing to some, it may even appear to be another investment "conundrum". But then investing is always a conundrum, despite what Alan Greenspan may say. If it weren't we'd all know where the markets should go, and they'd never move because we'd all be waiting for the same thing.

* Kevin Armstrong is chief investment officer of the ANZ National Bank.