Following significant market surges or declines, it's frequently noted that the stock market doesn't mirror the economy, nor does Wall Street represent Main Street. That distinction is becoming less clear.
TL;DR
- Rising stock and housing wealth significantly boosts consumer spending, a trend strengthening over 15 years.
- The wealth effect, amplified by digital media and retirees, increasingly influences consumer spending patterns.
- AI-driven stock market gains, particularly in tech, are projected to significantly increase yearly consumer spending.
- The economy's growing reliance on risk assets incentivizes the Fed and Congress to support the stock market.
This is due to rising asset values encouraging consumers to spend more readily, and since consumption makes up roughly 70% of GDP, this has a significant impact. Indeed, this so-called wealth effect has grown stronger over the past 15 years.
Today, every 1% increase in stock wealth translates to a 0.05% uptick in consumer spending, according to a note last week from Oxford Economics lead U.S. Economist Bernard Yaros.
A dollar increase in stock wealth results in a marginal propensity to consume of $0.05, a rise from under $0.02 in 2010. A $1 rise in housing wealth results in a $0.04 increase in spending, an improvement from $0.03.
“As households see their wealth rise, they turn more sanguine about their personal financial situation and are more inclined to loosen their purse strings,” Yaros wrote. “Increases in wealth will also propel spending by allowing homeowners to extract more equity from their houses or to liquidate appreciated stocks to fund their current consumption.”
As retirees increasingly make up a larger portion of the populace, he anticipates the wealth effect will further elevate the marginal propensity to consume in the years ahead.
Retirees, already possessing greater wealth than younger demographics, will increasingly depend on their assets to fund their spending once they cease employment and income generation, according to Yaros.
Furthermore, the widespread presence of digital media causes consumer sentiment to respond more rapidly to market developments, thereby strengthening these wealth effects, he stated.
This amplified wealth effect might shed light on why consumer spending has stayed resilient. Even as President Donald Trump’s trade war has kept inflation sticky and made businesses more nervous about adding workers in an uncertain landscape, AI is still propelling the stock market to new record high after At an all-time peak.
Simultaneously, the stock market's reliance on AI-centric companies, including chip giant Nvidia and major cloud providers Microsoft and Google, has increased.
Yaros's calculations, which consider wealth and spending, suggest that stock market profits from the tech sector over the past year will increase yearly spending by almost $250 billion, representing over 20% of the total. Of the total spending rise.
“While the stock market is not the economy, the latter risks greater whiplash from the ups and downs in the former,” he wrote.
Last month, JPMorgan analysts also examined the connection between the AI surge and consumers in a report. The U.S. Was estimated to be Over the past year, households saw their wealth increase by over $5 trillion due to 30 AI-related stocks, which boosted their annualized spending by approximately $180 billion.
This accounts for a mere 0.9% of overall consumption, yet JPMorgan observed that this figure might increase if artificial intelligence drives growth across a wider range of equities or in other asset classes such as property.
Wealthier Americans aren't the only ones who can invest in stocks. A recent a survey published last month by The BlackRock Foundation and Commonwealth revealed that more than half of Americans with annual incomes between $30,000 and $79,999 are participants in the capital markets as retail investors. Over half of this group started investing within the last five years.
Certainly, the richest individuals continue to disburse the largest sums, and the developing K-shaped economy has amplified their influence. According to Moody's research, the highest-earning 10% of individuals were responsible for 50% of expenditures during the second quarter, marking a new record.
Michael Brown, senior research strategist at Pepperstone, attributed that to the wealth effect from stock and real estate gains as well as from income disparities.
“Tying all this together produces two things — an economy increasingly reliant on discretionary spending among higher earners, and higher earners whose discretionary spending is reliant on risk assets remaining buoyant,” he said in a note on Tuesday.
This dynamic means central bankers at the Fed who control monetary policy and lawmakers in Congress who control fiscal policy have a greater incentive to support the stock market, Brown added.
That’s because the wealth effect can work in the reverse direction, meaning falling assets prices will slow spending and the economy.
Consequently, we're observing an economy that's becoming more dependent on the equity market's performance, and an equity market that's more influenced by total consumer spending. These two factors combined lead to "A more robust 'put' mechanism is in place to support risk assets, alongside ongoing fiscal stimulus and a more accommodating monetary environment," he stated.