The Two Effects of Stimulus Packages

Here’s a look at China’s Shanghai Composite Index compared to the S&P 500. In picture form, it’s quite easy to see how the two diverge.

Both stock markets bottomed around the same time – China’s a little earlier than the S&P 500, in late 2008.

Basically, China beat the U.S. to the stimulus punch bowl, unleashing a massive $586 billion package in early November of 2008. The Shanghai Index immediately rocketed higher, doubling in value by August of the next year.

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Meanwhile, the S&P 500 was still falling into the start of 2009. The market’s free fall was one factor prompting the American Recovery and Reinvestment Act of 2009. This package, passed by Congress in February 2009, was worth close to $800 billion. Much like the Shanghai’s response, the S&P 500 immediately shot higher.

But that’s where similarities between the Shanghai and S&P 500 end. Since August 2009, the Shanghai gave back nearly all of its gains. It’s now just 20% above the 2008 low.

The S&P 500, on the other hand, has continued to make new highs over the past three and a half years.

Stimulus packages typically have two effects. The first is a boost in market confidence. Businesses, consumers and investors alike generally feel more optimistic when significant stimulus plans are enacted. This effect, however, is somewhat short-lived and not real. It’s psychological.

The second effect is a direct, real one, as market sectors, institutions and businesses actually receive money flow from the stimulus.

China’s stock market clearly enjoyed the psychological boost in confidence in 2009. But after that, it seems much of the stimulus went into a black hole. Sure, it was spent on steel and copper for various infrastructure projects. And that infrastructure has an economic value. But the money failed to grow the overall value of China’s equity market.

On the flipside, U.S. stimulus efforts seem to have had a more “real” impact on the markets. Much of corporate America directly benefitted from the stimulus funds as profit margins expanded and equity values increased.

We here at Survive & Prosper, of course, continue to trumpet warnrnings about the market’s over-dependence on governrnment stimulus. We think it’s perverting the market’s natural mechanisms of deflation and deleveraging. But hey… at least we’ve gotten something from it. That’s more than the Shanghai can say.

With China’s stock exchange nearly as low as it was in late 2008, the governrnment is again looking at how to turnrn it around. In September it announced a stimulus package that would put $157 billion into 60 infrastructure projects. When combined with local governrnment programs, the stimulus is expected to total a whopping $1.74 trillion. That’s right, trillion with a capital “T.”

It’s very likely this sum will be enough to boost confidence again. The real question is whether or not it’s money well spent. If it all goes toward overbuilding ghosts towns, it could be more money down the drain.

If you haven’t done so already read the Survive & Prosper issue on “The Two Effects of Stimulus Packages.”