President Obama will unveil his jobs program one week from today. This is a big deal for investors -- the recent financial and economic crises have led to a lack of political consensus on economic philosophy, so it's difficult to predict what his plans will be. But we do have some historical context to consider.
President Roosevelt's New Deal agenda in 1933, President Johnson's Great Society programs of 1965, and Japan's fiscal policy measures of the 1990s -- all came about from the globally predominant economic theory concerning fiscal policy at the time: Keynesian economics.
Keynesian philosophy dictates that government spending and investment should expand when the private sector contracts.
The next question to answer is where should the government allocate financial resources. The answer to that depends on the economic and political environment. In general, however, we have a guideline to follow -- the fiscal multiplier.
The fiscal modifier is the measure of how much national income is produced for each dollar of government spending or investment. A fiscal multiplier of 1 means that national income will increase by one dollar for each dollar of government spending. Fiscal multipliers above 1 produce returns exceeding the costs and may be considered investments. Fiscal multipliers below 1 produce returns of less than that invested and may be considered spending.
Not all government-funded programs produce the same multiplier. Some are above 1; some are below.
In general, as simple as this concept is, it has been lost in the past few decades as government spending has exceeded government investment and the net multiplier effect has plunged.
A good analogy is the thought process a homeowner goes through when determining what improvements to make to his property. The return on investment is higher for some improvements than for others. And some simply represent sunk costs. (For the record, the greatest return is in improving kitchens and bathrooms. The least financial return is in a swimming pool.)
The same applies to federal outlays.
Obama needs to find a way to create jobs that Congress will sign off on. That requires a high fiscal multiplier. Infrastructure fits the bill, according to Keynes.
A slight problem: The fiscal plans introduced in the U.S. in the 1930s and 1960s, as well as Japan in the 1990s were focused on infrastructure, and all failed -- Japan spectacularly.
So in order to attempt to get a jobs program passed by Congress that relies on the same, the president will have to provide compensating factors such as tax cuts. However, even though there is a growing trend toward tax cuts and smaller government as a more stimulative response to a stagnating private sector, conventional economic wisdom still maintains that government spending provides a higher fiscal multiplier than tax cuts.
Tax cuts, though, have an immediate impact on consumption, and that is necessary right now too.
The bottom line is that the plan will almost certainly contain both. Here's how to play it.
The easiest way to invest on expectations of an expansion of infrastructure spending is through the largest banks, construction companies and conglomerates; JPMorgan Chase (JPM), Caterpillar (CAT), 3M (MMM) and General Electric (GE).
The plan should have little effect on large government contractors / integrators such as Lockheed Martin (LMT) and General Dynamics (GD).
On the tax cut side, the greatest potential impact should be on the consumer-focused companies: American Express (AXP), Wal-Mart (WMT), Home Depot (HD) and Ford (F).
