Debt, Deficits, and Investing
US government debt as a percentage of GDP (gross domestic product) reached 121% at the end of 2024. Many investors may have concerns about the impact of this level of debt on the stock market. While government spending associated with debt may provide a stimulatory effect on the economy, the prospect of higher future taxes and long-run impacts on spending and investment introduces many channels through which spending and debt levels might affect expected stock returns. But what investors may not realize is that the historical data show little relation between debt levels and stock returns. There are numerous examples of countries carrying high debt for extended periods while their stock markets posted double-digit annualized returns. One explanation is that stock markets set prices to the point where investors have a positive expected return given current information. Since country debt is a slow-moving variable, it’s sensible that current prices reflect expectations about the effect of government debt. Plus, economic theory does not offer a debt threshold beyond which a country is in economic peril. Dimensional’s Mark Gochnour, Wes Crill, and Jake DeKinder explore the implications of the rising US federal debt and discuss how investors should respond.