Stimulus in the Economy
Updated: Aug 20, 2020
If you follow the news, particularly business news, you have most likely seen headlines about “flooding the market with money”. At first glance, if you take what the talking heads have to say, you should panic, sell, buy, pivot, hedge, or simply do something to offset the massive inundation of fiscal and monetary stimulus. Everyone seems to have a voice, opinion, or insight to the stimulus, but no agreement on the answer.
Forecasting what federal stimulus will do to equity markets is as difficult as predicting any other variable in the markets. It is only plausible if you have a crystal ball. So, what can we say about the federal stimulus, and what are the takeaways? A strong financial plan should account for a multitude of market risks but let us take a deeper dive into the implications of vast sums of stimulus.
There are two types of stimulus: fiscal, and monetary. Fiscal stimulus is the money injected into the economy by Congress, and monetary stimulus is the money supply controlled by the United States Central Bank (The Federal Reserve). It is important to know that wide scale economic stimulus is nothing new. Roughly a decade ago, CNBC published an article quoting, “Indeed, some worry further bond buying could do more harm than good by providing tinder for inflation that will ignite when the recovery finally gains traction”. This was a response to the stimulus package of the Great Recession in 2008. It sounds oddly familiar, and the same sentiment of investors lingered then as it does now. If an investor decided to exit the market, or reallocate savings elsewhere, they would have completely missed out on the upsides of the great bull market of 2010-2020.
Secondly, the debt levels are not at historical highs. The highest federal debt as percent of GDP came during the second world war, spiking in 1946 at 119% (according to Federal Reserve Data). Albeit, current levels are quite high, 105%, and growing, but just the debt levels alone do not guarantee disaster ahead.
These high debt levels simply mean there is more debt outstanding than current earnings power. An analogy for this relationship could be discussed as a college student taking on loans for educated. The student employs debt for the chance of one day increasing his earnings potential. Such is the use of debt in the economy. Massive economic stimulus theoretically increases business activity to continue to be able to flourish, incentivizing cheap business investment and operations – thus improving national GDP.
Lastly, an increase in money supply does not directly cause inflation. Inflation is caused by two factors, the speed of circulation (termed velocity), and the money supply. While the money supply is at an all-time high, velocity of money is at an all-time low – balancing out and preventing inflation.
So, what if inflation skyrockets, the US GDP tanks, economic stimulus becomes futile, and the sky falls? Stick with the plan. A well-developed and researched investment plan will overcome these risks. Do you have annuities, or wide bond exposure subject to purchasing power risk? Are all your equities based in the United States, or do you have international exposure? Is your portfolio a traditional 60/40 fixed-equity allocation, or does it include uncorrelated alternative investments? Does your investment philosophy take into consideration only the past 10 years of trends, or is it academically researched with over a century of economic data?
If you cannot answer these questions, then perhaps action is necessary, but only because the financial plan was weak to begin with. Responding based on news, current events, or emotion always subjects us to biasedness, and ultimately results in poor decisions. The best plan takes long-term historical data into account and considers a wide variety of risk. Once a well put together plan is set, stick to it. Do not switch unless personal circumstances have altered.
If you handle investments yourself, or work with an advisor, always stay innovative, wise, and proactive on developing the best investment solutions. As a firm, Burkholder Wealth Management strives to excel in analyzing portfolios in full context. Many things may occur in investment environment, but some of the best advice will not be found floating around on talking heads! Invest wisely, and do not get caught up in predicting the unpredictable!