"As we anticipated in November, the Chancellor's initial forecast for 2009 GDP growth has proved wildly optimistic. In today's Budget, he has been forced to revise it substantially. The economy is likely to contract by 3.5% in 2009, a far cry from the 1.25% to 0.75% fall projected in the pre-Budget report last autumn.

"Moreover, the alarming growth in government borrowing is set to continue. The Chancellor expects public net sector borrowing to be £175bn or 12.4% of GDP this year, the highest level of debt since the Second World War. To fund this spending, the Treasury now plans to issue as much as £220bn of gilts, over £70bn more than the £148bn of sales outlined in the pre-Budget report.

"Such enormous sums are needed to cover diminishing tax receipts from the City, a beleaguered housing market and rising unemployment (the welfare bill for which reached the estimated level for the entire year in February). It must also pay for bank bailouts and insuring future losses, for which the government has already made a provision of over £50bn (3.5% of GDP). Overall debt levels, meanwhile, could rise as high as 79% of GDP by 2013, a level unthinkable a year ago when it was just 40%.

"So what does this mean for investors? Market reaction over the next few weeks will be crucial. If the market finds the Chancellor's assessment of the situation credible, then it should be able to absorb this massive increase in borrowing and gilt issuance. If on the other hand, investors perceive the UK economy as unattractive, they may prefer to buy the billions of dollars being issued by other recession-hit governments such as the US. Long term interest rates could shoot up and borrowing become more expensive. Sterling could also weaken further.

"The picture is further complicated by "quantitative easing" (otherwise known as printing money). The Bank of England is using £50bn of new money to buy government bonds until the end of May. In the Bank's first attempt at this unorthodox measure, it initially pushed up gilt prices. However, a failed auction later spooked the market and the prospect of a wave of new issuance could weigh heavily on gilt prices.

Deflation to be with us for a while
"Meanwhile, the economy remains weak despite signs that some areas may have hit the bottom. Retail price inflation has gone negative and unemployment has reached 2.1m.

"To counter some of these effects, the Chancellor is proposing to spend about £2bn on training schemes to tackle youth unemployment. This may bring down official unemployment figures, but fail to reflect the true nature of joblessness if more people work fewer hours and for lower pay. Such initiatives are, therefore, likely to have a limited impact while the economy deteriorates.

"Moreover, many believe the financial crisis is not over. The IMF has warned that banks have only written off about a third of prospective losses and could have to raise another £85bn to mend their balance sheets. Together these factors add up to yet more government borrowing. And to pay for all this debt, the government will need to curb public spending and increase taxes (beyond this Budget's higher bracket income tax rise). The latter could potentially hobble a recovery when it comes.

"As a result, I continue to believe that disinflationary and deflationary forces will be with us longer than many previously thought. The Chancellor predicts that retail price inflation will be -3% by September and zero by the end of the year. This is coupled with predictions that the economy will start to recover by December 2009, grow by 1.25% in 2010 and jump by 3.5% in 2011. Again, these predictions look very optimistic.

"As the global economy struggles, recession in the UK could potentially last well into 2010. We should be prepared for a few "false dawns" in the meantime and for the economy to bounce along the bottom before recovering. When a recovery does come, it is likely to be anaemic as consumers and government seek to clear the vast overhang of debts built up in recent years. If one were to visualise such an outlook, it would resemble more of a "ladle-like" recovery than the v-shaped recoveries we have seen in the past.

"Shares are therefore likely to be volatile for some time - creating a "hippo" market (characterised by high levels of volatility but no obvious long term direction). For example, in the last six weeks, we have seen a considerable rally led by financials and other cyclical stocks, albeit from a very low base, and this has led to talk of a recovery.

"However, we remain cautious. Until we know where the "bottom" is, investor sentiment is likely to be fragile. Nonetheless, a lot of bad news has already been priced in to markets and one is, in my view, starting to be paid for taking the risk of investing in equities on a three to five year time horizon.

Investor frustration
"In such an environment, it is understandable that some investors, who have seen stock market indices return to 1995 levels, may feel frustrated with equity investing. However, it is worth highlighting that while indices may have moved sideways in the past 10 years, the UK's best active fund managers have been able to make money during this period. One would expect that many will be able to do so, even if indices continue to move sideways, over the long term. Investors should also bear in mind that in such market conditions, averaging in exposure to the markets using regular savings schemes is particularly attractive for those investors who do not have a short term requirement for cash.

"The other significant question for investors is where they can get their income from. With interest rates in many countries at historic lows, investors' income will have dropped to critical levels. To achieve higher incomes, investors will have to take more risk. Given that the credit crunch has exposed many complex "manufactured" products as flawed - with capital often being sacrificed in pursuit of income - investors are more likely to seek out traditional income products, such as corporate bond funds and equity income funds.

"To that end, I welcome the Chancellor's decision to raise the ISA limit from £7,200 to £10,200 (available to those aged 50 and over from 6 October 2009 and to all from 6 April 2010). I would encourage the government to increase the limit every year to ensure the momentum this measure generates is not lost in the future.

"At Jupiter, our approach remains to invest in high quality companies with solid balance sheets that have the ability to grow in a difficult environment. It is part of the skill of Jupiter stock-pickers to identify which companies are likely to do well for investors over the medium to long term and emerge from this crisis in stronger positions than they entered it."

Please note that past performance should not be seen as a guide to future returns.  The value of an investment and the income from it may fall as well as rise.

NOTE
Jupiter Unit Trust Managers Limited (JUTM) and Jupiter Asset Management Limited (JAM) are both authorised and regulated by the Financial Services Authority and their registered address is 1 Grosvenor Place London SW1X 7JJ. They are both subsidiaries of Jupiter Investment Management Group Limited and the group is collectively known as "Jupiter". The above commentary represents the views of the Fund Manager at the time of preparation and may be subject to change and this is particularly likely during periods of rapidly changing market circumstances. Their views are not necessarily those of Jupiter and should not be interpreted as investment advice. Every effort is made to ensure the accuracy of any information provided but no assurances or warranties are given.