U.S. Fiscal Stimulus: Analysis For Investors

The recent talk of a second stimulus package ignores the fact that the original stimulus has barely been put into effect and assumes that a second package would be more targeted and would not threaten the dollar, heighten the risk of price inflation or cause the U.S.’s credit rating to be downgraded from AAA by further inflating the deficit.  For these reasons, a second package is unlikely, and thus, investors should not gamble on the outcome of the movement for a new stimulus package. Rather, investors should focus on, or at least be aware of, the details of the current stimulus package because its impact goes much farther than job creation. 

First, let us review the facts regarding the recently enacted stimulus package under the American Recovery and Reinvestment Act of 2009 (ARRA), passed by Congress on February 17.  According to Edward P. Lazear, professor at Stanford University’s School of Business and a Hoover Institution fellow, as well as Chairman of the President’s Council of Economic Advisers from 2003-2006, about $56 billion of the $787 billion package has been spent (see Op-Ed article published in The Wall Street Journal).  Thus, less than 10 percent of the total (which adds up to a whopping 5.4 percent of GDP) has been pumped into the economy. A report on the stimulus package by McKinsey & Company in the July 2009 edition of its business journal, McKinsey Quarterly [registration and/or subscription required], notes that 70 percent of the package will not be spent until the end of 2010.  In addition, a large proportion of the funds spent so far reflects mere transfers from the federal government to state governments, so the amount that has truly gone into the economy is significantly lower. 

Even if one deems all of the $56 billion spending, it is still too little to expect to find a significant impact on the economy. For example, by this point of the year in 2008, the Bush administration’s tax-rebates had pushed approximately $80 billion out the government doors and into consumers’ pockets. Most economists believe the rebates had a positive but unimpressive effect on the economy.  The effect showed up mainly in second quarter 2008 GDP, and was short-lived once the credit crisis hit hard in September 2008 and consumers, concerned about their outsized debt loads, began saving dramatically, crushing retail sales and, by extension, factory orders, at the same time the financial system was near collapse. 

Since the bulk of the spending won’t occur for another 1.5 years, with the rest trickling out after that, there is no factual argument to make that the stimulus package is not working and that more stimulus is necessary.  So, supporters of a second stimulus package will find it difficult to get one passed in Congress at a time when fears of inflation due to a super-sized federal budget are growing.

Thus, investors should primarily be concerned with the effect of the current package and not allocate assets based on the hope of a second package. The McKinsey report highlights two significant issues with the current package – the sectors of the economy most heavily targeted and the way the money is to be spent.  Three areas are specifically targeted in the plan: energy efficiency, broadband access, and medical records.  Government investment in these areas does not make for an easy personal investing decision.  Rather, one must spend time analyzing the new dynamic between government and the private sector in these areas to accurately determine if there is long-term growth potential and which companies may benefit most.  There is no such thing as a free lunch, and that includes receiving money from the government. 

Energy

In the energy sector, the Obama administration has set three sweeping goals: to create millions of clean-energy jobs over the next decade, to cut oil imports by two million barrels a day over the same period, and to slash greenhouse gas emissions by 80 percent, to levels below those of 1990, by the year 2050. The ARRA includes $97 billion in energy-related funding. Separate energy and climate bills now under debate in Congress include far-reaching provisions, such as cap-and-trade polices for carbon dioxide emissions. The 2010 budget would establish a regulatory framework to recast the energy sector’s fundamental economics. 

According to the McKinsey report, “The unprecedented speed and scale of the government’s commitment to technologies that use or generate energy efficiently, with minimal impact on the environment, will dislocate strategies and disrupt market shares in the energy sector for years to come. With the government assuming the role of primary banker and customer in many energy markets, industry executives must decide whether to rethink, and in some cases completely redraw, their capital and marketing plans.” 

All of these should be red flags to investors in the energy sector.  However, this does not mean that any such investment should be sold immediately and avoided altogether.  Energy, having been beaten down as much or worse than any other sector over the past year, has much to gain from any economic recovery, no matter how weak it may be.  Of course, the sector will become overbought rather quickly, as it did just recently between March and June.  The commodity pullback has offered some better entry points now.  Taking a longer-term view, the Obama administration’s efforts, to the extent they are enacted, will have a negative effect on the sector, if only because of the uncertainty they create, but also for the disruption in the markets those efforts will cause.  So, one must keep a close eye on whether and how many of those efforts go into effect. 

Technology

The technology sector will receive a big boost from the stimulus plan.  The ARRA directly targets high tech and telecommunications with $60 billion. In particular, $7.2 billion will be spent to increase broadband access by improving broadband infrastructure.  Including indirect spending the stimulus, the total outlay rises over $200 billion because every construction project requires heavy use of computers, software and IT services.  One key to consider when investing in the tech sector on the basis of the stimulus is whether the particular company has the necessary experience in government contracting to take full advantage in the stimulus.  Merely taking part does not equal automatic profit.  Another consideration is the spillover effect, especially with regard to broadband infrastructure improvements. For example, if hardwire, rather than wireless, technologies are favored as the preferred delivery method, consumer choices will be affected, thus creating competitive pressures within the telecom industry. 

Health Care

Finally, the expected spending in the health care sector may also be a technology story. To subsidize the use of electronic medical records, the government will spend $40 billion of the stimulus funds. “Technology vendors will thus have a chance to serve a new market: small and midsize physicians’ offices, often with fewer than five MDs each,” the McKinsey report explains. “Government spending should increase the adoption of electronic records from 5 percent of doctors now to 90 percent by 2019, according to the Congressional Budget Office. Vendors in the e-health arena (hardware, software, and IT services companies) must therefore rethink marketing strategies that target only larger companies. Many must not only learn how to offer flexible, physician-friendly products (such as software-as-a-service systems) but also reorient channel strategies to accommodate a sprawling, fragmented market of 400,000 doctors’ offices.”  The companies that can quickly adjust to a changing market can take advantage of these opportunities.  Note that it is usually not a mature organization that rises to the occasion but rather an upstart – remember that both Microsoft and Google were small companies formed during challenging economic conditions.  We’ll be watching this area closely. 

Conclusion

In sum, the government is poised to be much more directly involved in many sectors of the economy.  Investors cannot let political beliefs get in the way of their investment decisions.  While this author does not entirely agree with the government’s intrusion into the private sector, such disagreement will not replace objective analysis of the economic situation and its impact on investing.  There will be opportunities for companies to take advantage of the fiscal stimulus package.  Those among the first to invest in those organizations will benefit greatly in an extraordinarily difficult investing environment.