That was a compromise to appease a group of moderate Democrats who wanted the smaller bill to pass untethered from the larger. The fact that the vote was 100% on party lines tells us all we need to know about the politics of all this, but what does it mean for the economy and, more importantly here, for the market?
The problem with a lot of the commentary on this is that the framing of the story is controlled by the partisan politics of the framer. Those who generally support the Republican Party will point to the potential inflationary impact, the increases in taxation, and the probable increase in the deficit and therefore debt, and conclude that the market will collapse.
Democrats will point out that we are still a long way from full employment, so there is plenty of slack in the economy, and that the bill is designed not to increase taxes on households making less than $400k per year, but will still pay for itself. They would also say that the bills contain counter-inflationary measures such as an expansion to the housing supply, so the impact on prices will be minimal. If pushed, they would probably say that there will be no ill-effects on stocks, but the market isn’t their focus.
The hypocrisy, of course is that Republicans were quite happy with massive increases to the debt while their man was in the White House and, at that time, Democrats were upset about any spending when tax revenues were falling and were themselves voicing concern about deficit and debt levels. Oh, and both sides, of course, predicted a market crash when the other took power, and both were wrong.
If we strip out the politics, though, each faction has a point. It is a lot of stimulus, and the budget resolution does read like a Democratic wish list more than anything, but there are still a lot of people out of work, and taxing primarily high earners should have a limited impact on consumer spending.
On the other hand, is this a good time to increase taxes at all and to expand the social safety net? Given the still weakened economy and inflation that may or may not prove to be “transitory,” probably not.
The market response to the news yesterday reflected that murky outlook. The S&P 500 gained just seven points from Monday’s close in yesterday’s session.
It did set another all-time high, but seven points is hardly a ringing endorsement of the economic benefits of spending a combined $4.5 trillion. It seems that after a prolonged build up to yesterday’s vote, all the good news was priced into the market.
As true as that may be in the short-term, though, this is still good news for stocks.
Traders and investors have become accustomed to a market that has moved higher at a good clip, with occasional pullbacks that lose steam quickly. What these bills will do if passed is to make a continuation of that pattern more likely. The Fed has indicated that they intend to start reducing their bond purchases later this year, which is a precursor to rate hikes, and these bills will basically replace monetary stimulus with fiscal. There will still be a lot of money around that will step in to halt declines before they become much to worry about.
What the infrastructure spending package will do, though, is to shift where the majority of that money goes. Speculative growth plays have benefitted from a lot of investable cash in the system, but that is going away. Meanwhile, fiscal stimulus that will be spent in select industries is coming, so the obvious benefactors such as building and materials will outperform, along with other, “safe” areas of the market such as manufacturing and industrials.
The longer-term impact of all this, over the next three to five years, will depend on a couple of factors. If there is enough slack in the economy and the current inflation really is transitory, then inflation will fall, not rise, as the money is spent. If not, there will be trouble as the Fed scrambles to tighten rapidly and austerity could once again rise as a political concept. From the deficit and debt perspective, it is possible that yet more debt can be easily handled if the spending strengthens the economy sufficiently. A country’s debt is best measured as a percentage of GDP, so strong growth can offset big debt.
The main danger, though, is that we go through another unforeseen economic shock. If that happens, the Fed’s still bloated balance sheet will limit its monetary response, while an already committed federal budget will do the same in a fiscal sense. That would exaggerate a big future drop in terms of both size and time.
The basic message to investors here though, is that you should try to ignore the politically slanted opinions on these bills and look at their probable economic and market impact. That is positive, for now, and while there may be a rotation back towards value over growth as investors reckon with where the money will be spent, Congress just signaled some significant support for the overall market.
