by Denise Chisholm, Director of Quantitative Market Strategy, Fidelity Investments
Given recent headlines, investors have been concerned about the potential for a contraction in government spending. After years of well above average growth, would a reduction of âfiscal stimulusâ be a headwind for the economy, earnings growth, and markets? Government spending rarely shrinks historically, but we can look at the patterns and relationships between the variables.
And looking back to the 50s reveals a counterintuitive trend: periods of contracting or low government spending coincide with stronger market returns. Top quartile government spending hasnât necessarily generated a sell signal (equities still went up 70% of the time), but less government spending has been oddly better for the market â both in terms of odds and average returns.
This inverse relationship extends beyond market returns. Both real GDP growth and earnings growth have a similar relationship â historically less government spending is correlated with higher odds of growth. If you are thinking the data is heavily dominated by recessions, youâd be right. Government spending often increases during recessions, exactly when real GDP and earnings growth are weak.
But even if you exclude recessionary tails, re-quartile the data, you find the same negative relationship exists. The relationship between spending, economic growth, and markets are more nuanced than conventional wisdom suggests. Perhaps reduced government intervention creates an environment more conducive to private sector growth. Or perhaps government spending is just less significant (and other drivers more significant) for markets and the economy. Either way, investors should be wary of attributing too much weight to what might happen to spending, because it might be more noise than signal.
This information is provided for educational purposes only and is not a recommendation or an offer or solicitation to buy or sell any security or for any investment advisory service. The views expressed are as of the date indicated, based on the information available at that time, and may change based on market or other conditions. Opinions discussed are those of the individual contributor, are subject to change, and do not necessarily represent the views of Fidelity. Fidelity does not assume any duty to update any of the information.
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