Reasons to be disappointed

One thing seems certain - this Budget put the final nail in the coffin of old-fashioned value investing in equities
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I suppose my first reaction to last Wednesday's Budget was relief. Relief that the Chancellor did not do more. My second reaction was one of disappointment. Disappointment that the Chancellor did not do more.

My relief was that savings were not hit harder. My disappointment reflected fears that savings were not hit harder. My disappointment reflected fears that inflationary pressures have not been headed off. This is where the main problem could lie.

Retail sales are very buoyant just now and could well rise further, so the absence of more radical action is regrettable. It is not just that the City likes to see a degree of fiscal prudence in a chancellor. It is the way in which the baton has been passed so swiftly back to the Bank of England.

Few in the Square Mile would be surprised to see a half-point rise next week, with all the knock-on effects this would have. Perhaps the most serious is the added impetus it gives to sterling. The upward trend in the currency will not only damage exporters' positions further, it downgrades the value of overseas earnings for companies with extensive overseas interests.

Then there is the change to Advance Corporation Tax and Foreign Income Dividends. When FIDs were introduced, the shares of those companies able to distribute income to shareholders in this way were rerated upwards. We could have a subsequent downrating, particularly as these are the same companies likely to be affected by the strength of sterling.

The loss of the tax credit for pension funds is also serious. Many thought that abolition, which is what we got, would result in an immediate fall in share values. This did not happen. Perhaps part of the reason is that the measure was mitigated to some extent by a cut in Corporation Tax. But it does reduce the value of UK shares to pension funds. Many may now have to switch to government stocks in order to replace income, because actuaries like to see liabilities met out of dividend stream.

Pension fund managers will be reassessing asset allocation for their portfolios. Perhaps the fact that pension funds may have to buy more gilts will help this market, which has been unsettled both by the lack of action on consumer spending and by the prospect of base rates that may peak 1 per cent or more above the levels originally forecast at the beginning of this year. Eight per cent base rates look likely and 9 per cent not impossible.

One thing seems certain - this Budget put the final nail in the coffin of old-fashioned value investing in equities. There is still a body of opinion that believes shares pay for themselves through paying out high dividends. Companies will now have to find better ways of returning value to shareholders, although it is not beyond the wit of this Government to close any loopholes. Make no mistake, this was a socialist budget from a socialist chancellor.

Which is why we need to think carefully about Personal Equity Plans. The tax credit will remain for them until April 1999 at least. Why put a time limit on this benefit? Maybe the idea is that Individual Savings Accounts will be more restrictive than PEPs and then provide some form of transfer mechanism, before ending the tax privileges PEPs enjoy. PEPs are and have always been an ideal tax planning vehicle for the better off. ISAs are meant to extend tax-beneficial savings schemes to a wider range of individuals.

I would counsel a little caution at present, although it is clear from the initial reaction of the market that there is enough institutional cash about to soak up any short-term selling. Much will depend upon how America behaves. Opinion is still divided between those who believe that valuation levels on Wall Street have reached ridiculous levels and optimists who consider the US economy to be in a state of virtuous perpetual motion, helping to fuel a global bull market that still has a while to run. Even though I find the height of the US market alarming, there are no particular signs of nemesis waiting in the wings.

If you need income, a Corporate Bond PEP now looks a good bet. But this maybe a short-lived investment.

Investment is now a global business. The real players is markets these days move money around the world with alarming ease. If they are happy with UK plc, then we should not be too worried. Let us hope Mr Brown does not get more socialist as the life of the Government progresses.

Brian Tora is chairman of the Greig Middleton investment strategy committee and can be contacted on 0171-655 4000.

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