Closing Bell: Many have been blind to the harsh reality of UK's economic mess

IN MY last column I encouraged investors sitting on the spectacular gains of the previous year to take their profits, but writing this at the end of a day that has seen the FTSE fall to a level below that at which it started the year, I suspect few will have bothered to heed that call.

Perhaps being subjected to the endless posturing of politicians and their gushing promises of how everything will be better if only we will vote for them has blinded us to the horrible reality of just how big a mess our economy is in. There has been no talk whatsoever about the extent to which cuts are going to be enforced, especially in the public sector. There has been no mention of the fact that many governments have of late borrowed at a level never previously seen in peacetime, or that in spite of the phenomenal recovery in stock markets the deficit levels of pension funds have massively increased.

No, it has been far better to hang on to the merest suggestion of house prices rising, of exports improving or unemployment rates steadying.

In turn, this has in my opinion led to a return to the norm amongst investors. It has been far more comfortable to believe the headlines that inflation will soon spiral, and therefore equities is the place to be. We will seek to inflate away our massive mountain of debt and all will be fine if you invest in shares.

Now, at this point it is important to understand that I do of course appreciate the potential of equities.

However, I also believe it is extremely dangerous to adhere to the rather dogmatic view that "it has always been thus". Too many commentators also sought to assure us all that sub-prime woes in America were nothing to be overly concerned about, or that the credit crunch and its immediate fallout were once in a lifetime events, never to be repeated.

Jump forward to this year and it has been suggested that the issues relating to Greece and its inability to service debt is just a local difficulty. Really?

At the time of writing, there is now a growing acceptance that contagion of fiscal debt amongst the southern European nations is a very real possibility. In the UK, the first whispers of the true extent of our debt issues are beginning to be heard. The governor of the Bank of England is of the opinion that UK interest rates will remain at a very low level for some years yet, and there is a very real threat of sterling weakening significantly from current levels. While this of course greatly assists exports, it also weakens our ability to fund imported goods, on which we rely heavily.

Applying all of this to investors, it is worth pointing out that against a deposit interest rate of little more than zero, and a FTSE index that has shown no growth year to date, decent corporate bond funds have again delivered positive returns of around 5 per cent so far.

Over the past 12 months they have virtually matched the growth in the FTSE, and over three years outperformed it by around 40 per cent.

Over each of these periods, this has been achieved with negligible volatility. This should come as no surprise, as yet another example of just how much the world has changed in recent times is the fact that it is now arguably safer to lend money to a quality listed company than to many European governments.

Add to this largely benign inflation and static interest rates and you have a very good environment for carefully selected corporate bond funds. Be wary of anybody who tries to tell you this particular party is over.

We live in extraordinary times and unquestionably face a long and tough period of austerity. This will impact hugely on investors, and will challenge traditional thinking and beliefs. The buy and hold philosophy is likely to disappoint, and it will be the most disciplined and astute investors who will prosper, as inevitably volatility offers up phenomenal buying opportunities for those who are smart enough to maintain a decent cash balance within their portfolios.

In short, this time it really is different.

Ken Taylor is director of Mackenzie Taylor Wealth Management.