Attempts to spot recovery signals in the battered telecommunications industry have often foundered as each promising move forward instead proves to be the start of three painful backward steps.

But despite earlier false dawns descried by investors desperate to believe the value of their assets could not fall any further, persistent rays of light have appeared on the horizon in recent weeks. They suggest that the long decline from last year's stock market peaks may be over at last.

An obvious measure of this hope is the performance of key stock market indices. The Nasdaq index is up 30 per cent since its trough in early April. The FTSE European telecoms index has risen 13 per cent since its nadir in mid-March.

Unfortunately, even the most sophisticated chart experts can rarely distinguish between temporary rallies and the fabled bottom of the market. For every short-term analysis from stockbrokers proving shares are oversold, economists can produce equally compelling research showing that equity values remain at historically over-inflated levels.

Instead, telecom optimists point to subtler improvements in day-to-day sentiment which would have seemed far-fetched while share prices were still in free fall only weeks before. Who would have guessed, for example, during those gloomy winter months, that there would soon be a fierce three-way bidding war to acquire a former government-owned incumbent phone operator (Eircom of Ireland)?

Neither would it have seemed very likely, until it happened, that a European mobile phone operator, heavy with debt from third-generation licence payments and expensive acquisitions, would be able to raise £3.5bn from a surprise share placing in the space of just one morning, as Vodafone did.

Stranger still, is the idea that one of the sector's proudest companies would decide to replace its chairman, close its headquarters and sell its most prestigious foreign asset within less than a fortnight just to prove it was taking its problems seriously (although the British Telecommunications story is full of surprises).

Or that a European government not known for its love of big business would admit that it was too strict when auctioning mobile phone licences and voluntarily agree to relax the rules to compensate operators. Others may yet follow Germany's example.

Each of these stories needs to be examined in detail before wider conclusions are drawn, but to understand what will ultimately drive sentiment forward it is first necessary to isolate the factors which forced the sector's original fall from grace.

With the benefit of hindsight, these have become embarrassingly obvious. The euphoria of last year's stock market bubble simply made it far too easy to raise money for investment in telecoms, new media and technology companies. In the words of one investment banker: "Any idiot with or without a business model could raise finance in these conditions."

Not only did this lead to inflated expectations among investors, which eventually caused them to sell their shares in panic, it also created dangerous overcapacity among network operators, which put even more strain on their already fragile business models.

Once the atmosphere of too much investment inflow was replaced with one of too little, it was only a question of time before many of these cash-hungry start-ups started to go bust - dragging down equipment suppliers and other lenders with them.

The mood of the capital markets is closely aligned to the fate of almost everyone who works in the telecommunications industry. Like most high-tech industries, its staff are highly incentivised with share options, and changes in sentiment quickly ripple through suppliers and customers alike.

But above all else, fresh capital is the lifeblood of a young industry which needs to update its technology every few years. Once access to this rocket fuel was shut off, it was only a question of time before even the most elaborate starships began hurtling back towards earth.

In such situations, it is understandable that the technology which put them in orbit is called into question. There has been a crisis of confidence in the ability of the industry to deliver promised improvements in capacity (bandwidth) and cost efficiency through a series of key innovations.

In the mobile phone sector, critics have pointed to delays in the roll-out of third-generation networks and so-called 2.5G services such as GPRS (General Packet Radio Service) as a sign that the industry had exaggerated their importance.

Fixed-line customers have been alienated by the poor service levels which have accompanied the launch of ADSL (Asymmetric Digital Subscriber Line) technology in Europe and the US. And wholesale suppliers of bandwidth are beginning to accept they may have seriously overestimated demand for capacity in the backbones of many networks.

However, it would be as wrong to lay the blame for recent gloom at the door of the engineering department as it would be to look to the technology for instant solutions now. The introduction of new standards and protocols has always taken longer than first expected.

Such is the level of cynicism among investors that it will take more than the launch of a commercial 3G network before they are prepared to give operators the benefit of the doubt again. Instead they will demand to see sustained profits from large numbers of real customers \ 2 6 0 a process of recuperation that may take longer than the next business cycle.

The obsession with the growth potential of wireless data services was arguably an attempt to justify the soaring share prices encouraged by the Vodafone/Mannesmann takeover battle, rather than the cause of the bubble itself.

Instead, analysis of what went wrong suggests that the best hope for sustained recovery in the telecommunications industry lies in the natural tendency for capital markets to correct themselves.

The four examples of hope given earlier suggest this technical bounce is already under way. The bidding war for Eircom is, perhaps, the clearest sign that asset prices have fallen far enough to tempt back opportunistic bidders, particularly from the cash-rich private equity community.

Vodafone's share placing to fund its acquisitions of assets from BT was also a sign that public markets are beginning to discriminate between operators and can always be relied upon to come up with the cash if they spot a bargain.

Like a patient in therapy, BT is also making the first important steps to recovery by recognising the extent of its debt problems with a series of symbolic sacrifices. If troubled rivals, such as KPN and Deutsche Telekom, can show the same humility, Europe's incumbent operators may soon repair their balance sheets and start spending again.

Hints that the German government will relax rules preventing excessive co-operation among 3G operators could be the trigger for a much needed period of consolidation (however damaging this may prove for competition and consumer interests).

Unfortunately, the impact of the telecommunications slowdown on the wider economy is perhaps only just beginning. If recently announced job cuts and slowing output among manufacturing champions, such as Ericsson and Cisco, spill over into a wider economic downturn across Europe and the US, then lower retail confidence will inevitably weaken discretionary spending on products such as mobile phones or bandwidth-hungry consumer electronics.

Economic recession on this scale would not only wipe out any green shoots of recovery, it would make the last few months look like a picnic.