Not logged in. Login | Signup

Stimulus and your investments

2021-01-16, Michael Thompson

Share on facebook Share on twitter

Become an insider
Get the latest updates.


Stimulus and your investments

In 2020 the US government increased spending by almost 50% without increasing revenue. It spent over 6.5 trillion USD, with 3.1 trillion in deficit spending in the fiscal year! Meanwhile, the government offered almost a trillion dollars of tax relief. (See this link for further information on government spending: Fed budget FY2020.) Most of this was directly caused by stimulus spending. President-elect Joe Biden has promised further stimulus spending in 2021 and, with control of congress, will seemingly get what he wants. This has many investors wondering how their returns will be affected. Should we change our asset allocation? This article discusses potential impacts of increased government debt and stimulus spending.

Inflation

Inflation is the first thing many people think of when they see the magnitude of this stimulus. There are two types of inflation: monetary inflation and price inflation. Monetary inflation refers to an increase in the money supply, which has certainly taken place. The Fed has created huge sums of money in order to buy financial assets, increasing M1 as shown in this chart.

Significant price inflation–the rising cost of goods and services–has not occurred. While it may seem logical that monetary inflation would cause price inflation, the relationship is complex. For example, the Fed bought trillions of dollars of assets in 2008, but price inflation didn’t follow. Instead, much of that cash was stored as excess reserves by banks. This doesn’t impact the supply, demand or price of goods.

Perhaps more important to price inflation is the potential slow or decline in globalism and reductions in supply due to COVID-19. Globalism increases price competition and allows us to buy products from whoever can make them the cheapest, anywhere in the world. If we are forced to only buy toys made in America, we’ll have to spend a lot more to get them. Similarly, if factories, offices, etc. around the world are partially shut down, fewer goods will be produced resulting in higher prices. A counter to this, however, is that such closures tend to scare consumers into spending less money: the reduced supply is partially met by reduced demand.

Bottom line, if consumer spending rises (people get more confident) there will likely be increased price inflation, but it shouldn’t be too significant. Experts expect a moderate rise in inflation, but well below 4%. Now let's see how this impacts investments.

Inflation’s Impact on Assets

Inflation impacts investments. Bonds with fixed future returns become less valuable in an inflationary environment because those returns buy less. Stocks, however, can be robust to inflation as corporate earnings typically increase with inflation. The best hedge against inflation historically has been foreign stocks. For more information, please read our article " Investing and inflation".

A weakening dollar

The dollar is down about 10% since June 2020. Stimulus spending has likely contributed to this. Although not certain, many experts anticipate the dollar will continue falling. This typically benefits many investments including commodities (gold included), foreign stocks/bonds, possibly Bitcoin and even some domestic stocks. USD-denominated returns of foreign stocks are boosted by the exchange rate. This can even help US businesses sell products overseas: prices are relatively cheaper to foreigners, attracting more buyers. The biggest beneficiary of a weak dollar has traditionally been emerging markets.

The aim and the reality of stimulus checks

While there are various types of stimulus, checks sent to individual taxpayers is the most familiar. The primary motivation of these checks is to keep us buying stuff. The hope is that we’ll spend this money on desirable products and services which will help business and thereby reduce unemployment. A problem is that this money is generally spent slowly over time. For example, historical data indicates that stimulus checks in 2008-2009 did not result in appreciable spikes in household spending. People with more money in the bank tend to save their stimulus checks. People in debt tend to use these checks to pay off loans. Of course, both of these enable higher spending down the road, but it may be spread out months or even years after receipt. Hence, stimulus checks will increase corporate earnings over the coming year, relative to what they would have been without stimulus. This helps both domestic and international stock prices. Unfortunately, this is not "inside information"–the stock market has already priced this in. Did you notice how violently the markets reacted to stimulus news in 2020?

What about national debt?

In mid 2008 the U.S. federal debt held by the public was just over five trillion USD or 35% of GDP. COVID stimulus and the events of 2009 grew this debt to over 20 trillion USD by mid 2020 or 105% of GDP. That’s a 400% debt increase while GDP increased just 30%. While no one knows how much National debt is too much, this trend doesn’t look good.

So how does this impact our investments? It’s controversial. As the government has to spend more and more money paying interest on those debts, it may leave less money for infrastructure, military, and further stimulus. This would threaten efficiency, productivity and national security, reducing long-term stock returns. However, others believe the government can always print/borrow increasingly more and fund all these things. The extent to which this can work without devastating side-effects is hotly debated.

Whatever the case, most experts don’t see a significant near-term impact on your investments. As bad as it may seem, our debt-to-GDB ratio, which many experts point to as a useful value, is less than half of Japan’s. Furthermore, thanks to low interest rates, we are spending significantly less to pay off this debt.

Lower interest rates

Lower interest rates allow companies to borrow money more cheaply. This allows otherwise failing businesses to stay afloat. In the short term at least, this is good for business and stocks. For example, a company saved by low interest rates retains employees and purchases products from other businesses. However, in the long term this can be a bad thing. If this business is not efficient or useful it wastes resources that would have eventually flowed to more beneficial endeavors.

Lower interest rates of course also make it cheaper for you to borrow. This doesn’t necessarily mean it’s a good time to buy real estate, for example. If too many investors go after real estate you’ll pay more (possibly more than canceling out the interest rate savings) and not get a good return over time.

Are banks receiving money from the Fed

Banks are also receiving additional cash injections from the Fed. This is not free money, but a trade: the Fed purchases bonds that are held by banks. Banks agree to repurchase those bonds later or lose them. Banks prefer to pay back the cash as the bonds are worth more money. This was occurring at about a trillion USD per week, but stimulus doubled this to two trillion a week.

These actions by the Fed increase demand for bonds, which increases their price. At a higher price, bonds effectively return less: interest rates go down. As explained earlier, these lower interest rates boost businesses and stock prices in the short term.

Login to leave a comment.

Comments / Feedback

mrjon Feb. 2, 2021, 2:05 a.m.
cool

Related Articles

Inflation and investing

Should you try to beat the market?

Investing Basics: A most concise guide

Click here for a list of other recent articles.