The economy needs stimulus now

The economy needs stimulus now
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Now that the election is over, both parties should come together to help Americans recover from the damage wrought by the coronavirus. More federal spending combined with a Federal Reserve that continues to be accommodative are necessary to nurse the economy back to health. In addition to creating jobs and bolstering prosperity, government action would benefit the stock market, notably small companies.

Congress must enact a focused stimulus package with policies that have multiplier effects on the economy. This means fiscal support for important areas like infrastructure and broadband as well as targeted tax incentives. The fiscal support would produce jobs and increase activity while making the economy more productive. The targeted tax incentives, which should cover new tax credits for the purchase of homes or cars, would assist the economy in two areas with the highest multiplier effects.

Investors tend to account for the impact government actions can have on the stock market, which has priced in more stimulus. If the forecast does not become reality, it could have a deleterious effect on the stock market and, by extension, the economy. It is still worth bearing in mind that such influence any president could have on the stock market and the economy hinges on his ability to enact legislation. The country will have to wait and see what Joe Biden can achieve, which could depend on the Senate races in Georgia. If he secures a major stimulus, it should cause a rotation into more reflationary assets and assist small value companies.

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While a significant stimulus package would likely cause a sharp rotation into cyclical firms, that move could be more robust once the coronavirus vaccine becomes widely available. The recent news of effective trials from Pfizer and Moderna is very encouraging. As activity continues to increase, small companies should outperform their large siblings, and cyclical firms should outperform defensive areas of the stock market.

How would a stimulus package impact small companies? Since they are much more oriented with the domestic economy than large companies, their stock should feel those effects more swiftly and more profoundly. If demand increases even slightly and leads to more inventory, many small companies with strong finances will enjoy pricing power.

As an investor, I lean heavily toward cyclical firms which benefit from a strong economy. They can carry lower risk since they often are cheaply priced without a recovery, and are with sectors where capacity has been removed and end user inventory is lower. One headwind is the chance of a higher corporate tax rate with the new administration. Such increases would also have greater effects on small companies.

But the net effects of a generous fiscal stimulus package combined with targeted tax incentives would still favor the small companies in the stock market. As the economy starts to recover from a challenging but short recession, a significant stimulus would likely improve what is already a favorable climate for small companies. So what benefits the domestic economy should also benefit most small companies.

Charlie Dreifus is a managing director and a portfolio manager with Royce Investment Partners. His analysis above is not intended to be relied on as a forecast of future events or as investment advice and all views are his own.