Smart Investor: Don't let spending cuts uncertainty cloud your investment decisions

When David Cameron tossed the coin that decided how quickly the budget deficit should be cut, he should have been aware that whether it came up heads or tails, he was bound to lose.

If heads was a plan to reduce the deficit very slowly and tails a plan to cut it relatively quickly, the coin may have landed on tails, but he is still a loser.

The reason for this is that the UK government is faced with an impossible situation. It has to cut the budget deficit (and then the national debt) in order to maintain confidence in the UK economy, whilst trying to stimulate economic growth to maintain the tax receipts needed to reduce the deficit.

Sounds simple enough when put in one sentence, but in reality the coalition government will struggle over the course of this parliament to cut the deficit to zero, which is their aim.

They have most likely already accepted that unemployment will increase and tax receipts will fall, which will make the job of cutting the deficit even more difficult. Furthermore increased unemployment carries the double whammy of fewer people paying tax and more people claiming unemployment benefits.

So, any ideas on how they plan to cut the deficit?

In terms of income, taxation would normally be a good place to start. However readers with knowledge of the Laffer Curve will rightly say that the UK currently has the optimum level of taxation, both in terms of its rate and the willingness of employees to pay the higher rates. If tax rates were increased, this would likely cause a fall in tax revenues as individuals spend more of their time devising ways to avoid paying tax.

Spending cuts are an area in which the Conservative party would dearly love to enjoy carte blanche, but with the Liberals on board, they are restricted in what they can do. The NHS has already been ring-fenced, so £100bn+ per annum is already spent, whilst areas such as defence and education are necessities and cannot be relied upon to provide large-scale savings.

Welfare will most likely be the area where the lions share of savings are made. Unemployment benefit, tax credits etc will have to be reduced significantly, and don’t be too surprised if the pension age is bumped up by a few more years before the end of this parliament.

So where does this leave the intelligent investor? How can he benefit from this potentially lean period?

Often as an investor it is easy to develop a ‘feeling’ of how the economy is going to perform in future and then act upon that feeling. This article suggests that the UK economy will struggle over the next few years, but the truth is that the future is a known unknown. Ultimately nobody knows what events will occur during this parliament and how they will impact upon share prices.

All the intelligent investor can do is stick to the tried and tested method of apportioning capital between stocks and bonds based on value. No roulette, no blackjack, no crystal balls. Just buy when you think stocks are undervalued and sell when you think stocks are overvalued. You need accounts, not a coin, to help you decide that.