Finding a Balance

December 16, 2021

Source: Bloomberg Source: Bloomberg

Between deficit spending and the Federal Reserve’s (Fed) balance sheet, the government has put $26.4 trillion into the U.S. financial system since the start of the stimulus program in 2008. During that time, the S&P 500 Index has grown 220% (1.31%/month). After the initial stimulus period, there was a break in additional spending, which was followed by more stimulus starting in 2019.

From the start of the initial stimulus in 2008 through 2018, the additional spending averaged $115 billion a month, while the S&P 500 Index enjoyed an 89% gain (0.7%/month). As you can see in this week’s chart, when total debt and Fed purchases slowed to $49 billion a month, the S&P 500 Index became volatile then experienced a large correction, losing 44.27% (1.14%/month). 

There was a swift reaction to this, with almost $9 trillion spent in a 12-month period and an average of $428 billion in excess spending a month since September 2019. This put the S&P 500 Index back on track, with a gain of 20.69% (2.3%/month).

While all of this excess spending was occurring, inflation averaged 1.8%, which was below the 2% target the Fed had set as its optimal level. Recently, however, inflation has spiked to 6.8% and the Fed plans to gradually end its purchases by early 2022. The last time inflation reached over 6.8% was in 1978, and it stayed above 6.8% until 1982. During that time, the S&P 500 Index only returned 0.16% per month.

Government spending is also set to slow down from the $272-billion-per-month rate it has been at for the last two years. Even if the Build Back Better plan passes in its current form, it is projected that deficit spending will be reduced to an average of $107 billion a month over the next 10 years.

Key Takeaway

It remains to be seen how the S&P 500 Index will react to this current attempt to decrease stimulus, especially given the inflationary market. We have recently started seeing volatility in the S&P 500 Index as spending is about to slow down. This also happened in 2020 before a correction in the index.      

When total spending was reduced in 2018, inflation was around 1.8%.  This allowed the government to increase spending without too much thought about the effects it would have on the economy. Today, soaring inflation is the reason that spending will be reduced. If the markets start to perform negatively on the way to the 2% inflation target, it will be interesting to see if a balance can be found between S&P 500 Index performance and inflation.

Tags: Federal Reserve | S&P 500 Index | Inflation | Stimulus | Deficit Spending

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