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Does high government debt impact stock returns?

It's no secret that our national debt is massive and growing larger. Of course this causes some concern among investors and many of our clients.

I think this is a fair concern. If the government debt, and the interest on that debt, continues to rise it leaves less money on the table for the government to invest in services, projects, or improvements. With less public sector spending comes less private sector spending. This spirals into economic trouble and reduced stock market returns, right?

Not so fast. Dimensional Fund Advisors dug into this and found that there actually isn't much of a correlation here. High debt relative to GDP doesn't automatically mean lower stock market returns.

General government debt, percent of GDP vs. stock market return for developed markets, 1975–2022.

This chart shows developed country one-year stock market returns relative to government debt (as a percentage of GDP) from 1975–2022.

As you can see, when we move further to the right on the graph (higher debt to GDP) you don't see a pattern or trend downward that would indicate worse stock market returns for that year. (US specific years are the bold, black dots.)

What about high government debt over longer periods? There are a few examples in history of that too, and these examples still show positive stock market returns over the time period (examples in the article link below).

Of course we all have our own opinions about the government debt: what level is acceptable, what we should or shouldn't be spending this on, and much much more. This debate is endless and not why you read this blog.

I, for one find a little relief knowing that even with this large debt bill, doesn't automatically correlate to a negative return on the stock market or my investments.

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