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Recently, President Donald Trump released his administration’s 2019 fiscal year budget, totaling more than $4.4 trillion. A number that large can be hard to comprehend, let alone understand how it’s spent and its impact on investors.1
The federal budget is allocated between three main categories: mandated, discretionary, and interest on the national debt. Mandatory spending is government spending on programs that are mandated by law. The 2019 fiscal year budget allocates 62 percent of its funds, or approximately $2.73 trillion, toward mandated programs. Of that $2.73 trillion, $1 trillion will go toward Social Security, $625 billion will be allocated for Medicare, and Medicaid will get $412 billion.
Another 30 percent of the budget will be allotted for discretionary spending for domestic programs like healthcare, education, and public housing. What’s interesting, though, is that of the $1.20 trillion assigned to discretionary spending, more than 50 percent will go to the military. President Trump has significantly increased defense spending compared to the Obama and Clinton administrations. However, he’s not imposing the largest increases we’ve ever seen.1
Where does all this money actually come from?
Wouldn’t it be nice if money grew on trees? Since it doesn’t, the majority of funds for the budget, or $1.6 trillion, will come from income taxes. Social Security, Medicare, and other payroll taxes will add an additional $1.2 trillion, and the rest will be made up of corporate taxes, tariffs, earnings from the Fed’s holdings, estate taxes, and other miscellaneous revenue supply. But, when it’s all totaled, the Fed expects to only receive $3.42 trillion.1
$4.4 trillion – $3.4 trillion = A growing deficit
The proposed 2019 FY budget will create a deficit of approximately $1 trillion dollars for October 1, 2018 through September 30, 2019. You read that right…$1 TRILLION DOLLARS. And when you consider that the U.S. debt is already almost $20 trillion, it may make you question if all of the government spending is truly necessary and what type of long-term impact a growing deficit may have.
One potential consequence – long-term debt leads to a weakened dollar. And in an economy that’s already close to full capacity, a weakened dollar with less purchasing power may result in rising inflation over time. A growing deficit can also cause already rising interest rates to rise even further in an effort to attract Treasury buyers to help fund the mounting deficit.2 This is especially true as the Fed, one of the biggest Treasury buyers, unwinds its holding and leaves the market.
All of this has the potential to weaken a stock market that saw a boom during President Trump’s first year-plus in office. As interest rates rise, owning bonds leaves you with two tough choices: watch their value steadily erode or sell them at a discount.3 Stocks may also have a negative reaction to rising rates. When rates go up, interest payments on debt rise, which may dilute a company’s available cash flow for investment and dividend payments, leading to lower share price growth.4
However, the chart below points out how alternatives like commercial real estate and senior secured loans may not have the same negative reaction to rising rates.
The greater impacts of government spending for investors like you
Over the years, costs and spending have been rising steadily for key areas like defense and healthcare. Between 2000 and 2009, the total value of military assets rose by $341 billion. However, public investments in infrastructure assets like public building, roads, and mass transit have remained steady since the mid-1970s. What many don’t realize, though, is that this lack of spending on public infrastructure has a domino effect on the private sector. A recent study by Brown University showed that even a one percent increase in investments in core public infrastructure would increase productivity in the private sector by 0.2 percent.5 And while investments in the military may result in a growing economy, investments in non-military assets comparatively produce more economic gains in the private sector, potentially impacting equity investors significantly. Think of it this way; when a company’s infrastructure improves, so will its productivity, essentially increasing its value.
On the other hand, national healthcare spending has been on the rise since 1960, increasing by almost 13 percent. This double-digit increase represents trillions of dollars, a big plus for specific commercial real estate investments like healthcare REITs.6
What’s the future look like for government spending?
Government spending has risen quickly in recent years, and there are no signs of it slowing down. The rising deficit and a lack of adequate allocation to core public infrastructure has the potential hurt traditional asset classes.