The market is way up today. It is also up big for the week. It was up big in the month of May. It was up even more in the month of April.
What is different today is that unlike much of this previous rally that seemed disconnected from the news, today we got some great news. The unemployment rate, which was 14.7% in April, fell to 13.3% according to the Labor Department.
13.3% unemployment may not seem to be that good considering it was 3.6% in January. However, a recent survey by Dow Jones had economists expecting the rate to rise to 19.5%! They only were off by 2.5 million jobs or so, give them a break.
If you read my article last week, it may be less of a surprise as we looked at how the market could be rallying with so much of the news seeming to be negative. The reality is that the market, also known as the collective wisdom of billions of self-interested transactions per day, is nearly always a step ahead of the news.
None of this means we are out of the woods from the Covid-19 pandemic but it may suggest that we are learning to cope with it while getting on with our lives and livelihoods.
But What About Government Spending?
Another question on investors minds is how the increased government spending, $2.4 trillion and counting, will impact the stock market. According to the Congressional Budget office, the coronavirus stimulus is ultimately expected to more than triple the original 2020 projected budget deficit to $3.5 trillion!
That question was addressed in the same DFA article I referenced last week.
That brings us to the latest news headline worrying some investors: the eventual fallout from increasingly large US government expenditures designed to ease the economic burden of the COVID-19 pandemic. Will these efforts ultimately create a financial burden for the US government that affects future stock returns?
The results in Exhibit 2 should help allay concerns over the debt level impacting equity market performance. When we sort countries each year on their debt-to-GDP for the prior year (top panel), average annual equity premiums have been slightly higher for high-debt countries than low-debt countries in both developed and emerging markets. However, the return differences’ small t-statistics—a measure of the precision of a value’s estimate—suggest these averages are not reliably different from one another.1
The top panel uses prior year debt-to-GDP data to sort countries into the high/low groups. But investors may be more focused on where they expect the debt to end up, rather than on where it’s been. In the bottom panel of Exhibit 2, we rank countries on debt-to-GDP at the end of the current year, assuming perfect foresight of end-of-year debt levels. Again, average equity premiums have been similar for high- and low-debt countries. Like the results for GDP growth, these results imply that markets have generally priced in expectations for future government debt.
Exhibit 2: Debt Defying
Average equity premiums for countries sorted on debt
Past performance is not a guarantee of future results.
In other words, the current market prices already largely incorporate the expectations of the current government spending levels. One angle I heard this week from a prominent economist is that much of the stimulus spending is a one-time event and not the type of spending that structurally increases the deficit. I’m going to try that argument with my wife next time I make a large impulse purchase.
As always, if the current market has you second guessing your plans, get in touch for a review.