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A Thawing Economy-00-5394

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Alistair Darling's pre-budget report brought the biggest chill of all this Winter. Although miles better than the catastrophic previous year, it continued to expose the biggest budget deficit since the Second World War and Britain as the only big economy still stuck in recession. With the elections drawing near, Labour is riding on the hope that they will be given credit for at least steering the economy back to growth, but with GDP still shrinking into the third quarter of 2009, the general consensus may not be as optimistic.
Labour had targeted for Britain to emerge from recession in the fourth quarter of 2009, however official statistics are yet to be published on what really happened to GDP in the final quarter of 2009.

The government's fiscal changes and Britain's status on the international sphere will undoubtedly impact investor sentiment in the coming year. Shares on AIM fell 62% in 2008 as investors became increasingly wary of smaller companies and delistings rose to 73 in the fourth quarter of 2009, up from 63 in the previous three months. 23 of the delistings were due to AIM companies being taken over in the fourth quarter and 22 companies had to delist because of insolvency or financial distress, over double the amount that cited the same reasons for delisting a year ago. However, on a brighter note, 17 companies were also admitted to AIM in the same period which was the highest quarterly total since the second quarter of 2008.

Investors may have been wary of the AIM market over the last year as they have been on the main stock exchanges, but as economic stabilisation occurs, this will encourage riskier investments and AIM should see an increase in investor participation. Marcus Stuttard, the Head of AIM, certainly expects an upturn in IPOs after a tough year in 2009. AIM valuations are said to be unrealistically low and early signs of outperformance are already being seen. AIM revival is likely to be driven by resource companies as surging demand for precious metal, mineral and oil make some speculative and illiquid investment prospects listed on AIM more attractive. The high number of delistings from AIM last year also may not entirely be bad news as many of the delistings were driven by takeover activity and may have cleared the market for a ‘smaller and higher quality' market.

How the economy pans out strongly depends on whether Labour or Conservative is in power. The two differ radically on several fronts. Views on when deflationary fiscal measures should be introduced to reduce the amount of borrowing and debt that has been run up during the economic crisis is one of the dividing lines between the two parties. Labour is for delaying this fiscal retrenchment until 2011 whereas the Conservatives see this as a matter to be dealt with more urgently. Arguments for and against are equally convincing. Early retrenchment may interrupt recovery in 2010 and 2011 as the economy is arguably too fragile to do without government assistance, however, a delayed retrenchment will only cause the already alarming budget deficit to widen.

Another front is Labour's attitude towards tax. Changes in VAT, inheritance tax and now the new 50% tax on bank bonuses are clear examples of its willingness to tax the better off. The pre-budget report unveiled plans for an increase in National Insurance contributions on top of existing plans for a 0.5% increase. This is something that the Conservatives will work hardest to avoid because it will be a ‘tax on the many and not the few' and may effectively become a ‘tax on jobs'. The Chancellor also announced intentions on freezing income tax thresholds with an additional 70,000 people due to become higher rate taxpayers. Inheritance tax allowance would also be frozen at £325,000, something that the Conservatives want to raise.

The only change that the parties appear to be in agreement on is the new banker bonus tax. The tax has a strong political agenda, which is to stop banks that have benefited from government subsidies from handing out a large part of this year's subsidised profits in the form of bonuses. This is expected to raise around £550 million, which is to be spent on finding jobs for the unemployed. Some may argue that a tax on bonuses may have negative consequences on London as a financial capital, driving out some of the most highly paid individuals as well as star employees who relocate within their bank. Others question on whether the tax will make a difference to banking mentality as banks may now pay higher base salaries to compensate their employees for smaller bonuses.

About the Author:

Written by City Equities Ltd Research Dept. For those who invest in http://www.cityequities.com/ it is vital to access current market information to monitor market performance. To assist with this City Equities publish the online http://www.cityequities.com/en/Penny-Share-Review/Penny-Share-Review.html review every monday giving investors all the information needed in one place.

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