Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 64

Impact of deficits and surpluses on stock market returns

In Part 1, we looked at the record of Labor versus Liberal governments in running surpluses or deficits. Both sides have run very few government surpluses during their respective years since Federation.

In Part 2, we looked at the record of Labor versus Liberal governments in running up (and occasionally paying off) government debt. We saw that the current level of Commonwealth government debt (relative to national income) is modest, and is lower than almost any other time since World War 1. It is also lower than almost all other countries today.

Part 3 looks at what government deficits mean for share markets.

As investors we are not concerned here with debates about whether deficits are inherently good or bad, nor about inter-generational equity between current and future taxpayers, etc. We are primarily interested in the returns from shares in different fiscal conditions.

Chart 1 shows the annual Federal government balance plotted against real total returns from shares (including re-invested dividends and after CPI inflation). These are for years ending in June so they line up with the government’s fiscal years. Labor government years are shown in red and right-leaning government years (including Liberal) are shown in blue.

Chart 1: Federal government surplus/deficit versus real total returns from shares since Federation

Clearly the war-time years at the left of the chart dominate the overall picture, with very large deficits but also good stock market returns in most years (although returns during World War 2 were somewhat affected by war-time limits on share price movements). World War 2 was particularly good for business in Australia, despite the government’s measures to control prices and limit profiteering. Chart 2 shows the same story but for post-war years only.

Chart 2: Federal government surplus/deficit -v- real total returns from shares post 1946

Deficits are good for stock markets

There has been a mildly negative correlation or inverse relationship between government balances and stock market returns. Most of the high return years from shares were government deficit years (top left section). This includes 2011 and 2013 and the likely result in 2014 (remember all years are June years in this paper).

Deficits are generally good for shareholders and surpluses are generally bad for shareholders. In the post-war era the median real total return from shares was 10.8% pa in the deficit years but only 2.4% pa in the surplus years, which is a very significant difference. This is shown in Chart 3.

Chart 3: Real returns from shares -v- Government surplus/deficit - post-1946

There are two main reasons for this. The first is that deficits come about by governments spending more money (and/or taxing less), and much of the additional cash ends up in company coffers, either directly via contracting to the government, or indirectly via household spending.

The second reason is one of timing. Deficits tend to be high in mid-late recessions (when tax revenues are down and welfare spending is up), and this is when shares generally do best, rebounding out of the middle of recessions. This was the case in 1954, 1972, 1983, 1992 and 2010 (and in the pre-war years: 1922, 1923 and 1932).

Tax revenues and welfare payments tend to lag economic activity, both on the way into recessions and in the recoveries on the way out. On the other hand, stock markets tend to lead economic activity. As a result of these leads and lags, stock markets tend to do well in government deficit years, and tend to do poorly in government surplus years.

There have been very few years when government surpluses accompanied negative returns from shares (bottom right section). The most obvious instance was 2008, when tax revenues from the boom were still rolling in but shares were already falling in the GFC.

Some conclusions

History provides useful lessons, and some conclusions are:

  • Government deficit years have generally been good years for stock market returns. 2013-2014 will be a big deficit year and shares are heading for another good year to June 2014.
  • Government surpluses have generally been bad for shareholders, with significantly lower returns from shares compared to returns in deficit years.
  • The differences in returns between surplus and deficit years have been large and significant, regardless of which side of politics was in power at the time.

 

Ashley Owen is Joint CEO of Philo Capital Advisers and a director and adviser to the Third Link Growth Fund.

 


 

Leave a Comment:

RELATED ARTICLES

Budget time and Labor v Liberal on fiscal discipline

Federal Budget 2022: A “magic election pudding”

Living within one’s means

banner

Most viewed in recent weeks

Australian stocks will crush housing over the next decade, one year on

Last year, I wrote an article suggesting returns from ASX stocks would trample those from housing over the next decade. One year later, this is an update on how that forecast is going and what's changed since.

What to expect from the Australian property market in 2025

The housing market was subdued in 2024, and pessimism abounds as we start the new year. 2025 is likely to be a tale of two halves, with interest rate cuts fuelling a resurgence in buyer demand in the second half of the year.

The perfect portfolio for the next decade

This examines the performance of key asset classes and sub-sectors in 2024 and over longer timeframes, and the lessons that can be drawn for constructing an investment portfolio for the next decade.

Howard Marks warns of market froth

The renowned investor has penned his first investor letter for 2025 and it’s a ripper. He runs through what bubbles are, which ones he’s experienced, and whether today’s markets qualify as the third major bubble of this century.

9 lessons from 2024

Key lessons include expensive stocks can always get more expensive, Bitcoin is our tulip mania, follow the smart money, the young are coming with pitchforks on housing, and the importance of staying invested.

The 20 most popular articles of 2024

Check out the most-read Firstlinks articles from 2024. From '16 ASX stocks to buy and hold forever', to 'The best strategy to build income for life', and 'Where baby boomer wealth will end up', there's something for all.

Latest Updates

Investment strategies

The perfect portfolio for the next decade

This examines the performance of key asset classes and sub-sectors in 2024 and over longer timeframes, and the lessons that can be drawn for constructing an investment portfolio for the next decade.

Shares

The case for and against US stock market exceptionalism

The outlook for equities in 2025 has been dominated by one question: will the US market's supremacy continue? Whichever side of the debate you sit on, you should challenge yourself by considering the alternative.

Taxation

Negative gearing: is it a tax concession?

Negative gearing allows investors to deduct rental property expenses, including interest, from taxable income, but its tax concession status is debatable. The real issue lies in the favorable tax treatment of capital gains. 

Investing

How can you not be bullish the US?

Trump's election has turbocharged US equities, but can that outperformance continue? Expensive valuations, rising bond yields, and a potential narrowing of EPS growth versus the rest of the world, are risks.

Planning

Navigating broken relationships and untangling assets

Untangling assets after a broken relationship can be daunting. But approaching the situation fully informed, in good health and with open communication can make the process more manageable and less costly.

Beware the bond vigilantes in Australia

Unlike their peers in the US and UK, policy makers in Australia haven't faced a bond market rebellion in recent times. This could change if current levels of issuance at the state and territory level continue.

Retirement

What you need to know about retirement village contracts

Retirement village contracts often require significant upfront payments, with residents losing control over their money. While they may offer a '100% share in capital gain', it's important to look at the numbers before committing.

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.