The sharp sell-off of high-technology shares - towards the end of November the Nasdaq index had fallen 45 per cent from its historic peak - has left much of the valley bewildered.

"The stock market volatility is unprecedented and it is accelerating," explains Bradford Koenig, managing director of Goldman Sachs' investment banking division. "The market is a level lower than it was in early 1999. That is a huge correction."

The effect of this volatility has been almost immediate. Art galleries, European car showrooms and upscale architects have all reported a marked slowdown in orders. House prices and rentals - some higher than Manhattan - appear to have halted their relentless rise, and commercial property price increases seem to be moderating.

The collapse of many technology stocks has had three significant effects. The first has been immediate. A huge number of the inhabitants of Silicon Valley own shares and share options. A poll last month by Gallup showed that one in three households in Santa Clara county own options, 23 per cent in San Mateo, 21 per cent in San Francisco and 15 per cent in Contra Costa.

The owners of such options have seen their net worth collapse. Jim, a thirtysomething computer professional living in San Francisco, had been planning to use the options from his previous company to pay for a new floor to his house.

"Now they will buy a piece of furniture -a nice piece of furniture, but a piece of furniture nonetheless," he complains.

Worse, Jim's present employer has postponed its initial public offering, evidence of the second direct effect of the stock market sell-off.

Recent decline of initial public offerings

There is no doubting there has been a collapse in IPOs during the past six months. Jim's company is not alone - the flow of deals has slowed to a trickle with cancellations exceeding new listings.

During the first quarter there were 30 to 40 initial and secondary offerings a week, raising an average $7bn to $9bn, according to Morgan Stanley Dean Witter. But in the fourth quarter this year, there are just 10 to 20 deals a week, raising an average of $3bn to $4bn.

And those companies that have listed have performed poorly. Thomson Financial estimates that first day gains have dropped from nearly 100 per cent at the beginning of the year, to just 15 per cent. Worse, most are now trading under water.

The sell-off has been as widespread as it has been profound. After April, no investor wanted to touch business to consumer internet stocks, but gradually all sectors - business to business, mobile telecoms, internet infrastructure and even optical equipment - have been overwhelmed by the gloom.

"The market for IPOs?" asks Bradley Feld, self-designated "Shogun" at Softbank Venture Capital. "In one word - it's dead."

However, Mr Koenig at Goldman Sachs argues that there is still a market for high quality companies to go public. "There are key metrics and key sectors where investors will buy," he explains. The key metrics include large markets, strong, sustainable leadership positions, strategies to monetise those positions, a viable business model and a strong management team. "There is a return to traditional measures of selectivity," he says.

As for sectors, optical equipment, communications- related semiconductors and internet infrastructure - both hardware and software - remain of interest to investors. But for companies outside these sectors, the return to traditional measures has meant that many pre-IPO groups with negative internal cash are simply running out of cash.

Venture capitalists have become much more brutal than they were in cutting off funds to troubled firms. Companies that might have struggled on for months or years - termed by some venture capitalists as the living dead - have simply been shut down. There have been thousands of job losses, particularly among consumer-orientated web sites.

For Silicon Valley aficionados, the collapse of the consumer websites has been evident for more than six months. Along the side of 101, the traffic-jam masquerading as a highway running through the valley, are hundreds of bill-boards. At the start of the year, most were advertising consumer-related internet companies.

Among the most prominent was Garden.com's, which boasted a "living" billboard of flowers and trees spelling out its name. Alas, the trees died. Garden.com ceased trading.

Investors still keen, despite volatile market

But the resilience of American capitalism means that there is still optimism in the valley. The ability of the system to reallocate labour, land, capital and technology remains astonishing.

Investors continue to pour money into venture capital, in spite of the market volatility. The most recent PricewaterhouseCoopers Money Tree survey, released last month, showed that the pace of investment had slowed during the third quarter. It was the first time in seven quarters that venture capital investing had not hit new record levels.

Nonetheless, $17.6bn of venture capital was invested in the US during the quarter - double the $8.9bn in the same period last year. PricewaterhouseCoopers continued to predict that American venture capital investment this year would reach $70bn, double the $35bn of 1999.

What the survey did show was that the mix of investment had changed. More money was put into companies offering website security and traffic management systems, as well as access and infrastructure groups.

Other categories, such as services, content sites, business to business e-commerce sites and business to consumer sites, all experienced a fall in investments, quarter on quarter.

Moreover, the region that attracted the most money - by a large margin - remained Silicon Valley, with $6.9bn worth of investments, compared with $1.8bn in New England, and $1bn in the New York metropolitan area.

The IPO market may be subdued, if not dormant, but there are other exit strategies for venture capitalists and management. Some investment bankers expect the mergers and acquisitions market to pick up in coming months.

"In spite of the downturn, I am really bullish about M&A," says Robert Thornton, head of west coast technology M&A at Deutsche Banc Alex. Brown. "It is a period of growth in technology. You cannot stop its advance and the forces of consolidation are still strong."

However, Matthew L'Heureux, who runs Goldman Sachs' global technology mergers and acquisitions practice, is more doubtful about prospects for M&A, at least in the short-term.

"For the moment, there is a general stickiness. Some deals are on hold. Sellers want to see if their prices will go up. It's partly emotional and partly financial. As for the buyers, they have often seen their stock fall and have been given pause by the number of shares they will have to issue," he explains.

Nonetheless, longer term, Mr L'Heureux believes there will be consolidation. Companies such as Cisco and Broadcom continue to want to meet their customers' problems by broadening the range of businesses in which they operate, he adds.

The mood in the valley, Mecca of the information technology age, has changed. It is no longer so brash and confident. But its long-term belief in technology-led progress remains as strong as ever.