Budget stimulation and portfolio strategy: your …

Policymakers often use fiscal stimulus to fuel the economic embers and steer the economy towards long-term political goals. Should you incorporate budget spending indices into your portfolio strategy?

5 minutes to read

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Key points to remember

  • Fiscal stimulus can act as a tailwind for the wider market

  • The long-term effects of stimulus in the market send a mixed message

  • Track your goals when considering stimulus-driven portfolio strategy changes

Janet Yellen thinks we need it. Jerome Powell too. We’re talking fiscal stimulus, of course, and Congress seems poised to pass the third one over the past year, with encouragement from the Treasury Secretary and Federal Reserve Chairman.

Wall Street embraced the idea, with major stock indexes registering new all-time highs in early 2021 based (in part) on the hope that another stimulus could recharge the economy. But as an individual investor, are there specific ways to approach your portfolio strategy as more money flows out of Washington? Here is a preview.

Why stimulate, and why now?

“For years, the Fed has supported the economy through monetary policy, using a number of unconventional tactics, in an attempt to avoid deflation or a slowdown,” said Keith Denerstein, director of guidance at TD Ameritrade. “They begged Congress to supplement their policies with fiscal stimulus, but it took the pandemic for lawmakers to respond. “

It certainly helps that Yellen served as Fed chairman before joining the Biden administration as head of the Treasury.

Conventional wisdom suggests that stimulus measures can sometimes help sectors that benefit from infrastructure spending, such as materials or industrial products, and help growth sectors like technology. If inflation occurs because of an increase in federal spending, it can sometimes stimulate sectors that tend to benefit from inflation, such as financial services and consumer discretionary.

Past priority, however, paints a darker picture, making it difficult for investors to just log on and leave when Congress acts.

There are a number of precedents to consider, but here are two recent examples: the CARES law of last year, which injected around $ 2.2 trillion, and the 2009 stimulus during the last financial crisis, which was a just under $ 1,000 billion. If you’re an investor considering this new $ 1.9 trillion stimulus proposal that President Biden is expected to sign by mid-March, it’s important to understand what effect past stimulus measures have had on the market. .

But there’s the bigger problem: where the fiscal stimulus (and where it might be headed) should fit into your portfolio allocation decision.

Industry winners and losers and global “Sugar High”

First, let’s take a look at when, where, and why. Policymakers often use fiscal and monetary stimulus measures to fuel the economic embers and steer the economy towards long-term policy goals. As Denerstein explained, fiscal stimulus can be “a powerful accelerator of economic rebound, but its impact depends on how it is deployed.”

And the effect is generally felt in the financial markets; not just in the first few months after passing it, but over longer periods. From the start, a fiscal stimulus can give the market the equivalent of a ‘sugar high’, as investors contemplate the possible impact of a lot of cash on the economy, but the longer-term impacts are less clear. . And as Denerstein pointed out, “some policies could be used to increase consumer savings, with a smaller than expected increase in upfront spending.”

After the sugar peak, but before the stimulus makes its way into the economy, markets may go through a period of “regrets” where worries about possible overheating and inflation push stocks down. This is what appeared to happen in late February when the stock market hiccupped.

“At this point, the market response is driven more by fears that additional fiscal stimulus could overheat the economy, leading to soaring inflation, than by enthusiasm for increasing GDP than stimulus. could result, ”Denerstein said.

As an investor, it is more important to understand the long-term impact of stimulus measures and to remain cautious about short-term gains or losses in your portfolio.

For example, the CARES 2020 law – signed by President Trump at the start of the COVID-19 pandemic – may have been one of the factors in the “whole rally” that began last spring and continued for most of the year. It is said that a rising tide lifts all boats, and in this case this applied to the stock market … with the exception of two sectors:

  • Energy. When the economy returned home and locked the doors, the outlook for energy consumption plunged, hampering commodity prices.
  • Finance. Banks tend to struggle when interest rates drop to the basement.

The other nine sectors of the S&P 500 worked together, with so-called “defensive” segments of the market rising even as growth areas like communications technology and services led the way.

Lessons from the financial crisis and the 2009 recovery

It’s natural to think that growth sectors would always be the leaders in any sort of stimulus-related rally, but that’s not always the case. Let us return to the period 2010-12. The economy was emerging from the recession and had just received a stimulus.

A look at the performance of the sector then does not show much trend:

  • Technology topped all sectors in 2009, but did not finish in the top three sectors for the next three years.
  • Consumer discretionary and Immovable most often appeared in the top three between 2010 and 2012.
  • Industrial and Materials– two sectors which, according to conventional wisdom, should benefit from government spending – did not dominate.

The result ? In the long term, the stimulus measures of 2009 helped the economy, according to a report by the Congressional Budget Office. It added to real GDP and led to a reduction in unemployment. These are things that tend to help the stock market, so if it happens again with the new stimulus, the long term impacts could be positive overall, but the winners and losers in the sector might not be what you expect. .

Integrate fiscal stimulus into your long-term portfolio strategy

This time around, the stimulus may have driven up asset and house prices. Stock markets have seen risky assets soar, bitcoin cross the threshold, and retail trader participation rise. But this is the short term reaction and does not necessarily lend itself to a portfolio strategy, which requires a longer term view.

In the long run, all sectors fall for and against. Sometimes the market promotes growth, while other times it promotes value and stability. And depending on where you are in your investment journey, your goals and risk tolerance may or may not support the pursuit of sectors with the perceived “hot hand”.

And, as Denerstein explained, the market anticipates policy changes in advance, so by the time a stimulus bill is passed, its impact may already be factored into the markets. “At this point, if you are trying to research performance within an industry that you expect to receive stimulus for, you can prepare for a ‘sell the news’ event if the expectations don’t match. reality, ”he noted.

So, before you jump into stocks, sectors, and asset classes, take a step back and assess how fiscal stimulus can influence how you build your portfolio. The answer may mean considering not only your perspectives on different market segments, but also how they match your goals, risk tolerance, and time horizon.

Case in point: In the aftermath of the 2009 crisis, clean energy was one of the top political priorities (and stimulus goals) of then President Obama and Congressional leaders. Many investors have jumped on the water as the chart of the Nasdaq Clean Edge Green Energy Index (CEXX) in Figure 1 shows.

FIGURE 1: SLOW ROAD TO CLEAN ENERGY. After a relaunch in 2008-09, the Nasdaq Clean Edge Green Energy Index (CEXX, candlestick) retreated and chopped for a decade before exploding higher. Meanwhile, the energy sector (IXE, purple line) has experienced long periods of outperformance and underperformance. Data sources: Nasdaq, S&P Dow Jones indices. Graphic source: The thinkorswim® platform. For illustrative purposes only. Past performance is no guarantee of future results.

Note that after an initial explosion in 2008-09, CEXX retreated, then soared for more than a decade before rebounding on the rise in 2020. Meanwhile, the energy sector as a whole ( IXE) has experienced periods of outperformance and underperformance. However, the sector is dominated by large oil companies with a long history of dividends, while the clean energy industry contains many start-ups and growing companies that generally do not pay dividends.

A growth-oriented investor with a long-term horizon might be okay with the patience required to hold such positions. But what about a retiree who seeks income through dividends?

Conclusion on the stimulation and portfolio strategy

The rising tide of stimulus has the potential to lift all boats. But in reality, the stimulus may lift some more than others. Some boats do not lift at all. And some get a first boost but fall victim to a tide that can change quickly.

If you are looking to move your portfolio sails in the hopes of catching a stimulating tailwind, make sure you know the direction you are heading and that the wind speed is in sync with the time you plan to spend on it. the water.

Have a good trip!

Dan Rosenberg is not a representative of TD Ameritrade, Inc. The materials, views and opinions expressed in this article are solely those of the author and may not reflect those owned by TD Ameritrade, Inc.

Doug Ashburn is not a representative of TD Ameritrade, Inc. The materials, views and opinions expressed in this article are solely those of the author and may not reflect those owned by TD Ameritrade, Inc.

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