For stock investors, are there two different types of government deficits ? one that is bad for investors and another that is potentially good?

Government deficits occur when the various branches of the federal government spend more than the country collects in tax revenue and other income.

The government finances the deficits by selling U.S. Treasury Bonds and other debt instruments.

The problem is that when the government runs a high deficit it drives up interest rates because of the amount of debt instruments (bonds, etc.) it has to sell.

Interest Rates

This tends to raise overall interest rates, which is usually a bad thing for many investors. Although companies can adjust their prices to accommodate rising interest rates, only so many adjustments can be made before products become uncompetitive on the open market.
Rising interest rates make doing business more expensive because businesses have to pay more to borrow the money they need to operate. To understand more about how interest rate affect stock prices, read this article.

In this sense, rising deficits are not good news for investors because it tends to cause interest rates to climb, which increases the cost of doing business.

In most cases, a rising deficit is not good news for business, however, if the additional money is being used in some manner that increases economic stimulation, a rising deficit may actually help the economy.

Tight Spots

Increased jobs and capital investment funded by deficit spending has pulled the economy out of more than a few tight spots.
Huge government works projects helped the country recover from the great depression some 70 years ago.

What should investors do in the face of rising deficits? How do you know if this is going to be a ?good? deficit or a ?bad? deficit?

The main problem of rising deficits is rising interest rates. As the government sucks increasing amounts of capital out of the market to fund the deficit, businesses must pay more to borrow the money needed for expansion and so on.

Defensive Stocks

Investors who fear a large increase in the deficit is coming may want to consider shifting some of their portfolio to more defensive stocks such as consumer stables (think toilet paper). For more information on defensive stocks, check out this article.
Rising interest rates are good news for people who have cash to invest, especially if they are willing to lock it up for longer periods.

Conclusion

Investors have a stake in whether the government runs a deficit. Judging whether the deficit will stimulate or drain the economy is a difficult decision and one the experts can?t agree on in advance.