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 house prices close in on world record

Sydney is set to become the world’s most expensive city for housing over the next 12 months, a new report shows. Our other major cities aren’t far behind unless there are major changes to improve housing affordability.

The case for the $3 million super tax

The Government's proposed tax has copped a lot of flack though I think it's a reasonable approach to improve the long-term sustainability of superannuation and the retirement income system. Here’s why.

Tariffs are a smokescreen to Trump's real endgame

Behind market volatility and tariff threats lies a deeper strategy. Trump’s real goal isn’t trade reform but managing America's massive debts, preserving bond market confidence, and preparing for potential QE.

The super tax and the defined benefits scandal

Australia's superannuation inequities date back to poor decisions made by Parliament two decades ago. If super for the wealthy needs resetting, so too does the defined benefits schemes for our public servants.

Meg on SMSFs: Withdrawing assets ahead of the $3m super tax

The super tax has caused an almighty scuffle, but for SMSFs impacted by the proposed tax, a big question remains: what should they do now? Here are ideas for those wanting to withdraw money from their SMSF.

Getting rich vs staying rich

Strategies to get rich versus stay rich are markedly different. Here is a look at the five main ways to get rich, including through work, business, investing and luck, as well as those that preserve wealth.

Latest Updates

SMSF strategies

Meg on SMSFs: Withdrawing assets ahead of the $3m super tax

The super tax has caused an almighty scuffle, but for SMSFs impacted by the proposed tax, a big question remains: what should they do now? Here are ideas for those wanting to withdraw money from their SMSF.

Superannuation

The huge cost of super tax concessions

The current net annual cost of superannuation tax subsidies is around $40 billion, growing to more than $110 billion by 2060. These subsidies have always been bad policy, representing a waste of taxpayers' money.

Planning

How to avoid inheritance fights

Inspired by the papal conclave, this explores how families can avoid post-death drama through honest conversations, better planning, and trial runs - so there are no surprises when it really matters.

Superannuation

Super contribution splitting

Super contribution splitting allows couples to divide before-tax contributions to super between spouses, maximizing savings. It’s not for everyone, but in the right circumstances, it can be a smart strategy worth exploring.

Economy

Trump vs Powell: Who will blink first?

The US economy faces an unprecedented clash in leadership styles, but the President and Fed Chair could both take a lesson from the other. Not least because the fiscal and monetary authorities need to work together.

Gold

Credit cuts, rising risks, and the case for gold

Shares trade at steep valuations despite higher risks of a recession. Amid doubts that a 60/40 portfolio can still provide enough protection through times of market stress, gold's record shines bright.

Investment strategies

Buffett acolyte warns passive investors of mediocre future returns

While Chris Bloomstan doesn't have the track record of his hero, it's impressive nonetheless. And he's recently warned that today has uncanny resemblances to the 1990s tech bubble and US returns are likely to be disappointing.

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.