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.

 

  •   30 May 2014
  •      
  •   

 

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

The growing debt burden of retiring Australians

More Australians are retiring with larger mortgages and less super. This paper explores how unlocking housing wealth can help ease the nation’s growing retirement cashflow crunch.

Warren Buffett's final lesson

I’ve long seen Buffett as a flawed genius: a great investor though a man with shortcomings. With his final letter to Berkshire shareholders, I reflect on how my views of Buffett have changed and the legacy he leaves.

LICs vs ETFs – which perform best?

With investor sentiment shifting and ETFs surging ahead, we pit Australia’s biggest LICs against their ETF rivals to see which delivers better returns over the short and long term. The results are revealing.

Family trusts: Are they still worth it?

Family trusts remain a core structure for wealth management, but rising ATO scrutiny and complex compliance raise questions about their ongoing value. Are the benefits still worth the administrative burden?

13 ways to save money on your tax - legally

Thoughtful tax planning is a cornerstone of successful investing. This highlights 13 legal ways that you can reduce tax, preserve capital, and enhance long-term wealth across super, property, and shares.

Why it’s time to ditch the retirement journey

Retirement isn’t a clean financial arc. Income shocks, health costs and family pressures hit at random, exposing the limits of age-based planning and the myth of a predictable “retirement journey".

Latest Updates

Weekly Editorial

Welcome to Firstlinks Edition 639

Thank you for the hundreds of responses to our Reader Survey and to maximise the sample size, we’re leaving it open until this Sunday. Here is an overview of the results so far.

  • 27 November 2025
  • 1
Investment strategies

Where to hide in the ‘everything bubble’

It might not be quite an ‘everything bubble’ but there’s froth in many assets, not just US stocks, right now. It might be time to stress test your portfolio and consider assets that could offer you shelter if trouble is coming.

Investment strategies

The ultimate investing hack: dividend growth stocks

Investors often fall prey to ‘amygdala hijacks,’ letting emotion trump reason. By focusing on dividend-growth with stocks instead of volatile prices, you can steady your mindset and let compounding do the work. 

Investment strategies

CBA or global banks?

CBA’s recent pullback highlights single-stock risk. Global banks trade at lower P/Es with rising earnings and dividends, offering investors both income potential and long-term value beyond the local market.

Investment strategies

Global dividends rising, but Australia lags

Global dividend growth surged in the third quarter, with median growth of almost 6%. Australia was a notable exception as dividends fell, thanks to flagging mining company payouts.

Economy

I called inflation's rise and fall and here's what's next

In 2020, I warned that surging US money supply growth would spark inflation. By early 2023, I said US money supply was dropping dramatically and that meant inflation would decline. Here's what happens next.

Superannuation

Are excessive super funds giving Australia “Dutch Disease”?

The irony is profound: a system designed to secure Australians’ futures may be systematically dismantling the economic diversity necessary for long-term prosperity.

Investment strategies

Could your children pass the inheritance ‘stress test’?

You devote years of your life working, saving and investing, striving to build a legacy that will outlive you. Before any wealth moves to the next generation, here are six questions every parent should ask themselves.

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.