A quick look at a timely topic of interest - with a brief review of why it could matter to investors.

Chart of the Week
1 Likes

May 19, 2014

Bulls, bears and Federal spending
S&P 500 price level and federal outlays as % of GDP

chart

Source: Bloomberg, as of 3/31/14.  Past performance is no guarantee of future results. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

The bottom line:

  • Over the past few years, US federal government spending has grown more slowly, while the level of tax receipts has increased amid an expanding economy.
  • As a result, the federal budget deficit has narrowed dramatically, as has the level of federal spending relative to GDP.
  • One takeaway from a look back at market history—the secular bull markets of the last 100 years have generally been associated with periods where the size of the private sector trended higher relative to GDP; that is, when the economy grew faster than government spending.
  • The opposite has held for secular bear markets; during those periods, government spending has trended higher relative to GDP; i.e., government spending grew faster than the economy.
  • There are many ways to interpret this historical relationship; given the many anomalies that still prevail in the world economy, it's not clear how things may play out going forward. What does seem clear, of course, is that the debate over the impact of federal spending on growth and the markets won't be settled anytime soon.

The chart:

  • The chart shows federal government spending as a percentage of GDP and the S&P 500 price level over the past 45 years.
  • The chart encompasses:
    • Most of the 1966-1982 bear market (shaded area) when federal government spending increased relative to GDP
    • All of the 1982-2000 bull market when federal government spending decreased relative to GDP
    • All of the 2000-2009 bear market (shaded area) when federal government spending increased relative to GDP
    • The most recent five years, 2009-2014, when federal government spending has decreased relative to GDP

Context & Perspective:

  • Federal government outlays for the 12-month period ended April 30, 2014 were just over $3.4 trillion, almost exactly what they averaged for 2009; $3.4 trillion represents a 3.4% decline from April 2013 and a 6.4% decline from April 2011.
  • Meanwhile federal tax receipts have surged; at $2.91 trillion for the 12-month period ended April 30, 2014, are up almost 28% over the past 3 years and have jumped 43.6% from the low of January 2010.
  • As a result, the federal budget deficit as of 3/31/14 was just 2.9% of GDP, down from a peak of 10.1% at the end of 2009.
  • Meanwhile, federal spending as a percentage of GDP has declined from a high of 24% in March 2011 to 19.8% in March 2014—a level that is in line with the average of the past 45 years.
  • But total government debt outstanding has surged more than 60% in the past five years to $17.4 trillion, so all's not completely well on the US fiscal front.
  • Nonetheless, the story told by secular bull and bear markets over the past 100 years suggests that overall stock market performance has been better when federal spending grows less than the overall economy. Consider that:
    • From March 2009 through March 2014, the economy has grown by over 19%, but federal government spending has increased less than 4%; meanwhile, the real (inflation-adjusted) price of the S&P 500 increased over 120% during that same period. But for this most recent period. it should be noted that it's not certain yet if a new secular bull market began in March 2009, since the market has yet to surpass its real, inflation-adjusted high, reached in August 2000.
    • During the 2000-2009 bear market, the size of the economy grew by 43%, but government spending increased by almost 97%; the real price of the S&P 500 fell almost 59% from peak to trough —despite the uncertainty surrounding whether or not the most recent secular bear market in fact ended in March 2009.
    • During the 1982-2000 bull market, the size of the economy expanded by about 200% while the amount of government spending only doubled, up a little over 100%.  Meanwhile, the real price of the S&P 500 increased 470% from trough to peak.
    • During the 1966-1982 bear market, the size of the economy grew by over 300%, but government spending grew by more than 450%. The real price of the S&P 500 declined nearly 62% from peak to trough.
    • During the 1949-1966 bull market GDP grew by about 195% while government spending grew about 245%, making this period the exception to the other six periods mentioned. The real price of the S&P500 increased a little over 400% from trough to peak.
    • During the 1929-1949 bear market, GDP grew by about 158%, but government spending grew by more than 1,100%. The real price of the S&P 500 fell by nearly 68% from peak to trough.
    • During the 1921-1929 bull market, the economy grew by about 25% while federal government spending was cut in half; the real price of the S&P 500 increased 415%.

Sources

Bloomberg, Whitehouse.gov, S&P Shiller Market Data.

Definitions:

Gross Domestic Product ("GDP") is an economic statistic which measures the market value of all final goods and services produced within a country in a given period of time.

A secular bull market is defined as an extended period of cyclical bull and bear market movements, where each successive bull-market high and each successive cyclical bear-market low (inflation adjusted) is higher than the previous one.

A secular bear market is defined in the opposite manner - where each successive cyclical bull market high and bear market low (inflation adjusted) is lower than the previous one.

The S&P 500 Index is an unmanaged index of common stock performance. Please note an investor cannot invest directly in an index, and unmanaged index returns do not reflect any fees, expenses or sales charges. This information cannot be guaranteed and all liability is disclaimed on S&P's own behalf and on behalf of its information providers for any damages or losses arising from any use of this information. Returns prior to 1957 are representative of the S&P 90 Index, a value-weighted index of 90 stocks. Please note an investor cannot invest directly in an index, and unmanaged index returns do not reflect any fees, expenses or sales charges.


The opinions and views expressed herein, as well as references to individual companies or securities, are not intended to be relied upon as a prediction or forecast of actual future events or performance, or a guarantee of future results, or recommendations to buy, hold or sell, or investment advice.

Past performance is not a guarantee of future results.

All investments involve risk, including possible loss of principal.

Please note an investor cannot invest directly in an index, and unmanaged index returns do not reflect any fees, expenses or sales charges.

Equity securities are subject to price fluctuation and possible loss of principal.

Unless otherwise specified, all uses of the symbol "$" refer to US dollars.

This material is for information only and does not constitute an invitation to the public to invest in any funds, securities, strategies or other products. You should be aware that the investment opportunities described should normally be regarded as longer term investments and they may not be suitable for everyone. The value of investments and the income from them can go down as well as up and investors may not get back the amounts originally invested, and can be affected by changes in interest rates, in exchange rates, general market conditions, political, social and economic developments and other variable factors. Past performance is no guide to future returns and may not be repeated. Investment involves risks including but not limited to, possible delays in payments and loss of income or capital. Neither Legg Mason nor any of its affiliates guarantees any rate of return or the return of capital invested.

Please note that an investor cannot invest directly in an index. Forward-looking statements are subject to uncertainties that could cause actual developments and results to differ materially from the expectations expressed. This information has been prepared from sources believed reliable but the accuracy and completeness of the information cannot be guaranteed and is not a complete summary or statement of all available data. Individual securities mentioned are intended as examples of portfolio holdings and are not intended as buy or sell recommendations. Information and opinions expressed by either Legg Mason or its affiliates are current as at the date indicated, are subject to change without notice, and do not  take into account the particular investment objectives, financial situation or needs of individual investors.

The opinions and views expressed herein are not intended to be relied upon as a prediction or forecast of actual future events or performance, or a guarantee of future results, or investment advice. The information in this material is confidential and proprietary and may not be used other than by the intended user. Neither Legg Mason or its affiliates or any of their officer or employee of Legg Mason accepts any liability whatsoever for any loss arising from any use of this material or its contents. This material may not be reproduced, distributed or published without prior written permission from Legg Mason. Distribution of this material may be restricted in certain jurisdictions. Any persons coming into possession of this material should seek advice for details of, and observe such restrictions (if any).

This material may have been prepared by an advisor or entity affiliated with an entity mentioned below through common control and ownership by Legg Mason, Inc.

This material is only for distribution in those countries and to those recipients listed.

All investors in the UK, professional clients and eligible counterparties in EU and EEA countries ex UK and Qualified Investors in Switzerland:
Issued and approved by Legg Mason Investments (Europe) Limited, registered office 201 Bishopsgate, London EC2M 3AB. Registered in England and Wales, Company No. 1732037. Authorized and regulated by the Financial Conduct Authority. Client Services +44 (0)207 070 7444.

All Investors in Hong Kong and Singapore:
This material is provided by Legg Mason Asset Management Hong Kong Limited in Hong Kong and Legg Mason Asset Management Singapore Pte. Limited (Registration Number (UEN): 200007942R) in Singapore

This material has not been reviewed by any regulatory authority in Hong Kong or Singapore.

Qualified domestic institutional investors in the People's Republic of China (PRC), Distributors and existing investors in Korea and Distributors in Taiwan:
This material is provided by Legg Mason Asset Management Hong Kong Limited to eligible recipients in the PRC and Korea and by Legg Mason Investments (Taiwan) Limited (Registration Number: (98) Jin Guan Tou Gu Xin Zi Di 001; Address: Suite E, 55F, Taipei 101 Tower, 7, Xin Yi Road, Section 5, Taipei 110, Taiwan, R.O.C.; Tel: (886) 2-8722 1666) in Taiwan. Legg Mason Investments (Taiwan) Limited operates and manages its business independently
This material has not been reviewed by any regulatory authority in the PRC, Korea or Taiwan.

All Investors in the Americas:
This material is provided by Legg Mason Investor Services LLC, a U.S. registered Broker-Dealer, which may include Legg Mason International - Americas Offshore. Legg Mason Investor Services, LLC, Member FINRA/SIPC, and all entities mentioned are subsidiaries of Legg Mason, Inc.

All Investors in Canada:
This material is provided by Legg Mason Canada Inc. Address: 220 Bay Street, 4th Floor, Toronto, ON M5J 2W4. Legg Mason Canada Inc. is affiliated with the Legg Mason companies mentioned above through common control and ownership by Legg Mason, Inc.

All Investors in Australia:
This material is issued by Legg Mason Asset Management Australia Limited (ABN 76 004 835 839, AFSL 204827) ("Legg Mason"). The contents are proprietary and confidential and intended solely for the use of Legg Mason and the clients or prospective clients to whom it has been delivered. It is not to be reproduced or distributed to any other person except to the client's professional advisers.

FN1411799

Previous Editions

Click on a date to view that week's edition of charts.

Poll

Which Asian country will have the strongest growth in the coming year?








Poll

Which Asian country will have the strongest growth in the coming year?

Japan, as Shinzo Abe's policy initiatives take hold
(16%)
India, as Narendra Modi's new government enacts changes
(35%)
China, as Xi Jinping's reforms promote a stronger financial sector
(19%)
South Korea, as President Park Geun-hye's plan to boost growth bears fruit
(30%)



Previous month Poll

Go for growth: Where will a global recovery be strongest this year?

Europe, as countries emerge from bailouts
(43%)
US, as consumers regain optimism
(40%)
Japan, as stimulus programs begin to bear fruit
(7%)
China, as reform and pro-growth policies continue
(10%)