Muddle-through markets

Sure, easy credit, as supplied by central banks' quantitative easing programmes, worked its wonders on financial assets - the sort whose value can oscillate wildly without anything actually happening - and had far less effect on real assets. But even the prices of financial assets are tethered - however elastically - to what's happening in the real world, which was not all that much. True, the UK escaped its dreaded triple-dip recession, but by a margin so slim that revisions to output - which usually end up as greater than the first stabs at estimating the figure - could yet make the triple dip a reality. The land of the brave did quite a lot better - US output for the first quarter was up 1.8 per cent on the year - but even that rate implies that output fell even further behind potential.

So a rest in share prices could be both justified and rationalised - especially considering how little the balance sheet of the developed world has improved since the onset of what the International Monetary Fund labels the 'Great Recession'. To understand that, look no further than the factor that contributed most to getting us into this mess - debt. Using World Bank data and some time-lapse sampling, it is easy to see how the developed world's government debt soared in response to the crisis, but shows no sign of falling relative to output (see 'Still deep in it').

Arguably, the erosion of the personal sector's debt is more important than the public sector's. The logic is that government debt rose hugely to help keep the worst effects of the collapse from the likes of you and me, but in the coming years the onus for recovery must switch back to the private sector (companies and consumers). So how quickly consumers restore order to their finances and how they behave subsequently matter greatly. Here, the signs are more encouraging. The table also shows that UK households' debt in relation to income fell by an eighth - from 174 per cent to 152 per cent - from its peak at the end of 2007 (and had dropped further to 146 per cent by the end of 2012).

That's good, but let's not get too excited. Even the end-2012 figure is well above the average for the 25 years 1988-2012 when debt to household income averaged 130 per cent. And while ultra-low interest rates help, for consumers to feel comfortable with their debt, the debt-to-income ratio may have to drop to well below its long-run average.

Given that, it is deeply ironic that finance ministers and central bankers alike base their plans for recovery on getting the private sector to borrow more - after all, when was it sensible to say of anything: 'Too much is bad for you, but a little more will help'? But there is nothing terribly new in using this remedy. For the past 30 years much of the developed world's growth has been driven by borrowing, helped by the liberalisation of the finance industry.

That the authorities resort to the familiar (albeit dressed up in innovative packages) reveals that debt-driven growth is the easy option. It requires no effort to play around with monetary aggregates. It would be far more effective to make the structural changes that the developed world so badly needs - dismantling the licensing raj in the US and the EU's regulatory raj; diluting the EU's employment law; getting tough with pampered pensioners. Easier said than done. That would mean taking on powerful minorities each of which has an incentive to keep its lucrative privileges that is stronger than the incentives of governments to reform them.

Which is why we get muddle through. And why we should expect muddle through in the developed world's financial markets. In this analogy, equity markets have risen fast because they can and they have got well ahead of the real economy. Now they must bide their time, or even retrace some steps, to align with the muddling economy.

Inspiring? Hardly, but it's the reality that we deal with and one that prompts few changes to the Bearbull Global Fund - maybe some tinkering with weightings in the iShares MSCI World exchange traded fund (SWDA), ditto the holdings in oil and currencies. Nothing more than that.