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Reflation is Nigh

TLDR: when a large stimulus is announced, Oil posts the strongest gains, along with consumer stocks



As the one-year anniversary since the WHO declared COVID-19 a pandemic rapidly approaches, there is some hope on the horizon considering declining caseloads and accelerated rates of vaccine distribution. Even with these positive signs, the United States (and the world at large) is still experiencing the economic damage that the pandemic left in its wake.


You may be wondering, “how should I position my portfolio for the next few months?”


President Biden has made his new administration’s top priority to curb the pandemic and its economic impact. He has pushed congress to enact a $1.9 trillion dollar stimulus package that includes direct cash payments, augmented unemployment benefits, money for testing and vaccine distribution, and state and local financial relief, among other benefits.


This would be a historically large spending package, similar in magnitude to last year’s “Coronavirus, Aid, Relief, and Economic Security Act” (CARES Act) enacted in March of 2020 when the pandemic first hit. It’s likely to have a rippling impact on many sectors of the economy. You may be wondering, “how should I position my portfolio for the next few months?”


The S&P 500 index typically dips initially, adhering to the old adage “buy the rumor, sell the news”


We looked at five of the largest expansionary fiscal policy/stimulus packages passed in the last twenty years to find out.


1. 2001 Economic Growth and Tax Relief Reconciliation Act

2. Economic Stimulus Act of 2008

3. American Recovery and Reinvestment Act of 2009

4. Tax Cut and Jobs Act of 2017

5. CARES Act of 2020


Examining returns after these acts were signed into law by the President (they had already been passed by the Congress), you’ll notice an interesting behavior — the S&P 500 index typically dips initially, adhering to the old adage “buy the rumor, sell the news”. It then rallies, getting back to breakeven after 2 weeks and continuing to rise the remainder of the 3 month period, as the expansionary fiscal policy makes its way through the economy.


You may be thinking, doesn’t the market typically rise over time? You would be right - you can see the typical return over a quarter highlighted in blue below - but you’ll notice that, post-stimulus, the S&P 500 typically outgains by 4.21%.



Key takeaways for the S&P 500 response from five prior stimuli

  • After two weeks, the S&P 500 index DECREASES, on average, by 1.82%

  • The index then does a sharp turnaround, ending up with an overall average increase of 5.59% three months after POTUS signing

  • This is in contrast to the average S&P 500 movement for every quarter from 2001-2020: +1.38%, meaning the S&P's gains are 4.21% GREATER in the three month period after a stimulus is signed than after the baseline three month period

Given the (frequent) concerns about fiscal stimulus leading to inflation, you may wonder how commodities will fare.


Let's see the graphs!


Key takeaways for the commodity complex

  • Crude Oil was the biggest winner of the four commodities analyzed, increasing by an average of 35.94%

  • Gold, typically thought of as an inflation hedge, actually only had relatively modest gains, giving returns no greater than 8.81%

And what about the S&P sectors? Do they follow a similar pattern?



Key takeaways for S&P Sectors

  • Consumer Discretionary, Industrials, and Information Technology won every time except the 2001 anomaly

  • Given the strong relationship of consumer discretionary goods to economic health), Consumer Discretionary was one of three sectors to rise above an average of 9%

  • Other winners include Financials and Materials

  • Utilities was the only losing sector, decreasing by an average of 3.32%

Let's dive deeper into each bill.


2001 Economic Growth and Tax Relief Reconciliation Act


The 2001 Economic Growth and Tax Reconciliation Act was an income tax cut pushed by the Bush administration in response to the 2001 recession. Signed on June 7th, 2001, this bill changed other aspects of the tax code such as expanding the Earned Income Tax Credit and raising the child tax credit.


Here is what happened to financial markets after its implementation:





The 2001 Economic Growth and Tax Relief Reconciliation Act, which was implemented in the midst of the brunt of the 2001 recession, did not curb widespread market downturns. The only exceptions were small gains in consumer staples and gold which were likely seen as safer options amidst the recession. As we will later see, the results from this legislation were uncharacteristic.


Key Takeaways from the 2001 stimulus

  • Unlike the other four pieces of legislation, the S&P 500 index decreased three months after the President signed the bill. Market losses were almost universal.

  • The S&P 500 index decreased by 11.23% at the end of the three month period

  • Natural gas was the biggest loser among the commodities analyzed, decreasing by 37.76%

  • All sectors decreased except Consumer Staples which increased by 3.21%

  • Unsurprisingly, Information Technology was the biggest loser, decreasing by 26.01%

Economic Stimulus Act of 2008


The Economic Stimulus Act of 2008 was signed into law by President Bush on February 13th, 2008. This legislation was the result of concerns of an impending recession due to worrisome economic indicators. This bill provided individual tax rebates for the 2008 tax year, created new business tax incentives, and increased the threshold for conforming loan limits that the Federal Housing Administration was allowed to insure.






Similarly to the trends of the aggregated equity market benchmarks above, the Economic Stimulus Act of 2008 led to initial dips in these benchmarks before rebounding to an overall gain at the end of this three month period. These final gains were muted compared to some of these other examples, possibly reflecting the relatively smaller cost of this package at just roughly $168 billion. Though outperformance was reflected in the energy sector (crude oil and natural gas commodity prices as well).


Key Takeaways from the 2008 stimulus

  • The S&P 500 index had its characteristic initial dip, bottoming at a decrease of 6.86% 18 trading days after signing

  • It then rallied to an overall increase of 1.54% at the end of the three month period

  • The energy sector was the big winner, increasing by 14.03% at the end of the three month period. Additionally, crude oil and natural gas rallied to 33.19% and 34.73%, respectively

  • There was some variance in sector performance: Healthcare was the biggest loser, decreasing by 5.88%

American Recovery and Reinvestment Act of 2009


The American Recovery and Reinvestment Act of 2009 was a $787 billion dollar relief package signed by President Obama on February 17th, 2009. To curb the effects of the “Great Recession,” it proved a mixture of tax relief, unemployment benefit extensions, and allocated money for federal contracts to spur private sector investment, among other spending.






After the American Recovery and Reinvestment Act was signed, we see the initial dip in the equity benchmarks before a positive rally. This rally in the S&P 500 was larger in this stimulus package than the 2008 economic stimulus package. Most notably, the financial sector rebounded to the greatest extent, possibly reflecting the beginning of the recovery after the issues that surrounded many financial institutions that predicted the economic crisis.


Key Takeaways from 2009 stimulus

  • The S&P 500 index bottomed at a 14.27% decrease after 14 trading days, but rallied to increase overall by 13.17% at the end of the three month period

  • Commodity performance was mixed, with gold and natural gas losing slightly, while crude oil and copper increased substantially with returns of 61.29% and 41.92%, respectively

  • Nearly all sectors increased (healthcare and utilities lost slightly)

  • Financials were the big winner, increasing 45.31%

Tax Cut and Jobs Act of 2017


The Tax Cuts and Jobs Act (TCJA) was a 1.5 trillion dollar tax reform law signed by President Trump on December 22nd, 2017. Unlike the previous examples, it was not enacted during a recessionary period. It made significant changes to the tax code. It lowered marginal tax rates, lowered the corporate tax rate, and made changes to some of the itemized deductions.





The period following the implementation of the TCJA, followed a slightly different trend than the previous two stimulus packages, which increased expenditures rather than cut revenue. The equity benchmarks show a dip in the middle of that three month period rather than the beginning of it, before rebounding into a gain reflecting an overall bull market. There was a significant disparity between the returns of specific S&P sectors. Information technology and consumer discretionary performed the best, while communications and consumer staples were the biggest losers.


Key Takeaways from 2017 stimulus

  • The first month after implementation, the S&P 500 index rose substantially, peaking at a 7.06% increase

  • The index then dropped, finishing up 1.25% at the end of 3M

  • Consumer Staples and Telecommunications were the biggest losers, decreasing 9.02% and 9.10% percent, respectively

  • While certain sectors decreased, Consumer Discretionary and Information Technology were the biggest winners, increasing at 5.49% and 6.08%, respectively

CARES Act of 2020


The Coronavirus Aid, Relief, and Economic Security Act (CARES Act) of 2020 was a 2.3 trillion dollar stimulus bill that was enacted on March 27th, 2020, in response to the economic fallout from COVID-19-related restrictions. It was the largest distinct spending package in U.S. history. The CARES Act included provisions such as direct aid to taxpayers, forgivable loans to small businesses, increased unemployment benefits, and other relief to industries impacted by the pandemic.






The largest discrete spending package among these examples preceded the greatest overall gains in these equity benchmarks. The CARES Act was passed along with unprecedented expansionary monetary policy, and financial markets responded. The initial dips that occurred in the two previous expenditure packages were far more muted this time. The following gains were more substantial across the different sectors as well. Commodity prices overall also showed substantial gains with the exception of natural gas futures, which showed a small dip.


Key Takeaways of the 2020 stimulus

  • The period that succeeded the signing of the CARES Act represented an almost universal market increase

  • The S&P 500 index increased by 23.21% at the end of the three month period

  • Among the four commodities analyzed Natural Gas was the only loser, decreasing by 4.43%

  • Every sector increased with Consumer Discretionary, Energy, and Information Technology as the big winners

  • Those three sectors increased by 31.77%, 29.61% and 30.07% respectively at the end of the three month period

So what does that mean for the current stimulus package?

Given markets remain near all-time-highs, how might the new stimulus impact price action? Though we are technically out of a recession, many parts of the economy do not feel so. Unemployment remains high, and many industries have large structural hurdles to overcome as life becomes more "normal" again.


Given the magnitude of stimulus, perhaps 2020 is a good proxy. The major difference being that, currently, the S&P 500 is barely off all-time highs vs down 25%+ a year ago.


So maybe 2017 provides a better example - the market was also at all-time-highs then, and stimulus came outside of a recessionary period. But the situation is very different now - the hospitality industry is still reeling, and many more Americans are out of work.


If either case can be a lesson, markets are likely to respond favorably to Biden signing a stimulus into law.

And what about my portfolio?

Given sharply rising rates and looser policy from the Fed, many investors are worried about inflation. Looking through history, this "reflation" concern seems to have been misplaced, with Gold typically seeing a muted response.


So...if not gold, how do I position?


Consumer Discretionary stocks are likely to perform well as the economy restarts and people get back to, well, consuming. The energy complex has already seen a big rally, but there could be room to rise further. Finally, Industrials and Materials may see rises, and investors should likely avoid Utilities.

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