The pros are buried in it. But how deeply is the falling market burrowing into consumer psyches? It’s an urgent question for policy makers trying to subdue inflation while guiding the economy to a soft landing.
University researchers Marco Di Maggio, Amir Kermani and Kaveh Majlesi have one way to quantify it. Their 2020 study says every dollar lost in stocks leads to a 3-cent reduction in spending. After the five-month selloff, that’s about $300 billion zapped this year. Americans have about $18.5 trillion in annual disposable income, strategists at Bloomberg Intelligence say.
Viewed that way, the numbers depict a tightening squeeze, though one that by itself would need to get worse to seriously constrict Americans’ free-spending ways. As swift as the repricing has been, it’s coming at a time of elevated savings and rising pay for many workers.
Indeed, for a Federal Reserve bent on wringing excesses from the economy, the data may support bearish views that wealthy Americans remain richer than central bankers would like.
“Consumer net worth, household net worth are up so much,” said Jim Paulsen, chief investment strategist at Leuthold Group. “Everything you had on your balance sheet went up by so much for so long. I don’t care if it was a stock, bond, any commodity you had, rare art, I mean everything. So to the extent there’s a pullback, it’s a ripple.”
Yelena Shulyatyeva at Bloomberg Economics notes that wealth effects work with a lag and much of the market’s volatility has yet to land on sentiment. She uses a model that adds real estate to the psychological mix. Home-price gains slowed to 12% in the first quarter, and if that were to be annualized, she estimates stocks would have to drop 30% from their peak to “wipe out” the wealth effect from housing. If home-price gains slow further to 5%, the drawdown in stocks would already be large enough to scotch sentiment.
While there’s usually a hit to consumer balance sheets during market routs, Americans who own stocks generally count among the wealthiest.
“Most of the people who own stocks in this country also have a lot of accumulated savings, trillions of dollars in aggregate,” Brian Nick, chief investment strategist at Nuveen, said by phone. “And a lot of those folks are not highly leveraged. They’re not running up huge credit-card bills. They’re spending down cash savings.”
A quarter of household wealth is tied to equities, according to Wells Fargo estimates. That’s enough to pose a threat to spending if the selloff continues.
“When equities are down like this, it can weigh on sentiment. If we stay down at these levels, we could see that souring sentiment really start bleeding into consumer spending,” Anna Han of Wells Fargo Securities LLC told Bloomberg TV this week. “These are the indicators we’re watching, and the consumer is decelerating, but it’s not like the spending faucet is being shut off.”
To be sure, inflation and higher borrowing costs could have a bigger impact on consumer spending than stock-market levels, especially for lower-income Americans, a group that is less likely to own stocks. US consumer prices rose by more than forecast in April to 8.3% on an annual basis. Average household debt repayments will grow by $450 to $510 this year due to rising interest rates, according to Bank of America.
That said, the Fed’s work is already being felt in financial conditions, a measure of stress across equity and fixed-income markets. Di Maggio, a professor of finance at Harvard Business School, says it’s top of mind for policy makers when they’re thinking about how their actions ripple down to the consumer.
“They always think about, if we set rates, we change market conditions,” he said by phone. “And a key way this percolates through the real economy is through portfolios.”
How declining stock prices impact consumer sentiment — already at the weakest level since 2011 — may be a point of debate, but one thing that isn’t is the link between very big market drops and the economy. Almost never has a 20% drop in the S&P 500 not come with a recession in the last 100 years, a fact that could imply a limit to how hard the Fed is willing to push on monetary policy.
To date, the central bank’s actions have only barely slowed a robust jobs market, where there are more open positions than there are people willing to fill them, and where the unemployment rate sits at 3.6%, near a 50-year low.
Di Maggio says there’s a lagging effect. “We are in a very good economy right now. The stock market is falling down, but the job market is still strong.”
Trillions in losses of stock wealth have yet to show up in retail spending. Data out on Tuesday showed US retail sales grew at a solid pace in April, suggesting demand remains resilient despite rampant inflation. Bank of America data, meanwhile, shows payments were up 25% year-over-year in April, with total credit- and debit-card spending up 13%. Spending on travel and entertainment has continued to trend higher, the bank said.
“The consumer momentum and strength has been much stronger than just about anyone would have thought,” said Dennis DeBusschere, the founder of 22V Research. “This has been a worry of ours — the consumer staying too hot for the Fed.”
Fed chief Jerome Powell has endorsed the retreat in financial conditions, and one of his colleagues, Mary Daly, said she’d like a further tightening.
Lauren Goodwin, economist and portfolio strategist at New York Life Investments, says she foresees a few more months of strong consumer trends. On the bright side, lower-wage workers have seen a particularly pronounced uptick in pay during the pandemic recovery. Her main concern, however, is that higher costs for everyday essentials, like gas or baby formula, could depress sentiment.
“The key question for investors is does that drag in consumer sentiment start to create a real drag on consumer spending, which then ripples through the economy,” she said in an interview. “I would expect that the strong support consumers have had up to this point and the real cash savings that the consumer generated during the pandemic on aggregate, that these drags on sentiment, including the wealth effect, are outweighed by those positive factors, but that is, of course, the critical question for moving forward.”
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