Stocks Benefit from Fiscal Irresponsibility

From 1970 through 1984, the return of the S&P 500 outperformed inflation by 1 percent per annum.   From 1985 onward, the S&P has outperformed CPI by 8 percent annually.  The expansion of government deficits and a falling personal saving rate go a long way in explaining the much-improved performance of the stock market. 

The chart compares corporate profits to the amount of savings in the economy.  Prior to the 1980’s, annual Federal budget deficits were usually around 2% of GDP and households were saving about 8 percent of GDP.  Together, government and the people were net savers of 6 percent of GDP.  Today, the annual federal budget deficit is 6% of GDP, and people are saving around 2% of GDP.  The U.S. economy went from saving 6% of GDP to consuming 4% more than we produce.

Financial relationships may show correlation, but not necessarily causation.  However, in this case, the relationship between declining savings and elevated corporate profits is cause and effect and established by an accounting identity1..  Although the negative consequences of fiscal irresponsibility may eventually rear up, the trend of government and consumers spending more and saving less is likely to continue, which supports corporate profits and equity returns.

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