Smith on funds: Grim reaper of debt may come knocking

On the face of it, everything looks fairly rosy. Over the three years to August 2007 the FTSE All-Share index has delivered a total return of 62.04%, with smaller companies and mid-caps especially delivering yet more impressive gains.

Several short-term jitters have been replaced with renewed confidence and yet higher prices.

The most recent bounce, following the US Federal Reserve Board’s decision to cut its key interest rate by 50 basis points, has left UK equities at higher levels than the start of this year.

The UK retail prices index has risen by some 10% over the last three years, while the UK’s real GDP growth has been below 10% – even when compounded.

These numbers reflect huge, short-term, real gains in equity-based wealth, not merely inflation compensation and participation in the UK economy’s real growth with a modest ‘equity risk premium’ on top.

Indeed, those numbers would suggest an annual equity risk premium well into double-digits over the last three years.

While some of this differential may reflect participation in stronger growth elsewhere in the world – given UK equities are far from a pure domestic exposure these days – it seems to me a fair amount represents optimism about the future that may well prove unjustified.

I can’t help worrying the market has taken all the good news and largely ignored the bad and now has a feeling of desperation about it.

While our new prime minister, Gordon Brown, can proudly boast of the longest period of uninterrupted economic growth in the UK’s history, this itself comes on the back of him, as chancellor of the exchequer, turning a 3% budget surplus into something like a 4% deficit over recent years.

Eddie George, the ex-governor of the Bank of England, openly admitted the Monetary Policy Committee slashed interest rates to avoid recession before leaving his legacy to Mervyn King to clear the mess up.