The recent Federal Budget in Australia and the upcoming equivalent annual fiscal statement in New Zealand always generate significant media coverage and can raise questions among investors about the implications for asset prices arising from the governments’ projections for revenue, spending, public debt and major economic variables like inflation and growth.
While not as significant in absolute or proportional terms as major economies like the US, the UK, France or Japan, public debt in Australia and New Zealand is still sizeable, at around 38.6% and 52.8% of gross domestic product respectively.1
Yet, we can see in the chart below that there has been little relationship between central government debt and stock market returns over the past few decades. In fact, this lack of a link holds true even for the nations with much higher levels of public debt such as the US, whose equity market has been one of the world’s best performing in recent years.
How can this be? Firstly, the call of governments on capital markets is public information and is already reflected in the prices of both stocks and bonds. These prices are set to the point where investors have a positive expected return given current information.
Secondly, country debt is a slow-moving variable, so it’s sensible that current prices reflect expectations about the effect of government debt.
Thirdly, public debt is but one of a myriad of variables that can affect security prices. These also include company earnings, technological innovation, inflation and the level of interest rates, consumer demand, sectoral trends, and mergers and acquisitions.
This isn’t to say that governments are not significant players in capital markets or that their spending and revenue decisions do not warrant attention. But investors are better off sticking to a sound investment plan designed to achieve long-term goals than trying to second-guess what trends in public debt will mean for their portfolios.
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