Stocks finished a volatile week with a surge into the close Friday, helped by a boost from President Biden’s doubling of the U.S. vaccine rollout target and the Federal Reserve’s decision to free banks from restrictions on dividends and buybacks. Also, the final consumer sentiment index for March rose to 84.9, the highest since March 2020.
Last week a third round of relief payments started showing up in the accounts of millions of Americans, $1,400 payments so far sent to roughly 90 million adults totaling about $242 billion. That is on top of $600 per recipient payments sent in December and $1,200 sent earlier last year and in all will add up to more than $800 billion.
The big question for the economy: What will come of the money?
Future Wealth’s View
In “A Theory of the Consumption Function,” Milton Friedman proposed a theory that became known as the permanent income hypothesis. It states that households don’t spend cash windfalls because they manage their spending for the long run. If they think taxes are going to go up in the future to pay for government borrowing in the present, they will save a windfall check from the government because they don’t think it is permanent. Repeated tests of Friedman’s hypothesis showed that people tend to spend roughly one-third of the money soon after getting it, with the rest being saved or used to pay off debt. Consistent with the theory, the Federal Reserve Bank of New York showed that households last year saved 36% of the first round of their relief payments, paid down debt with 35% of the money and mostly spent the rest of it.
Now, with repeated payments to the same individuals, it is expected that the savings having been satisfied with the first and second rounds, the entire amount of the most recent stimulus will trickle down to consumption. If it were to happen, coupled with reopening of restaurants, hotels, amusement parks, movie theaters and so on, we could be witnessing an epic spending spree that could buoy the economy and the stock market.
For investors, the message is simple – stay invested but pick the sectors wisely.