In recent months, the perception that the stock market and the economy are distinctly separate entities has evolved, as rising asset prices appear to be positively impacting consumer spending. This shift is notable, with consumption accounting for approximately 70% of GDP. The phenomenon known as the “wealth effect” has gained traction over the past 15 years, indicating a correlation between stock market performance and consumer behavior.
A recent analysis by Bernard Yaros, lead U.S. economist at Oxford Economics, sheds light on these dynamics. He notes that for every 1% increase in stock market wealth, there is a corresponding 0.05% rise in consumer spending. This is a significant increase from a mere 0.02% in 2010, suggesting a more profound emotional or psychological connection between wealth and consumption.
Housing wealth also plays a role, with each additional dollar in housing wealth yielding a 0.04% increase in spending, marking a modest rise from 0.03% in previous years. Yaros explains that the rising wealth inspires households to feel more optimistic about their financial situations, leading them to be more willing to spend. This includes tapping into home equity or liquidating assets to support current consumption.
Looking ahead, Yaros anticipates that the wealth effect may amplify further, particularly with a growing retiree demographic that typically possesses greater net worth than younger generations. As these older individuals transition into retirement, they are likely to depend more on their accumulated wealth to sustain their lifestyles.
Another factor contributing to the wealth effect is the rapid dissemination of information through digital platforms, which enables consumer sentiment to shift more quickly in response to market news. This trend could help explain the resilience of consumer spending, noted even amid economic uncertainties, such as trade tensions impacting inflation and corporate hiring decisions.
The stock market, fueled in part by advancements in artificial intelligence (AI), has been breaking records recently, with notable companies like Nvidia, Microsoft, and Google leading the charge. Yaros estimates that stock gains in the tech sector alone could result in an annual consumption boost of nearly $250 billion, representing more than 20% of the total increase in consumer spending.
Additionally, analysts at JPMorgan have assessed the correlation between the AI surge and consumer wealth, estimating that U.S. households collectively gained over $5 trillion from AI-related stocks last year. This increase could raise annual spending by approximately $180 billion, although it currently constitutes only 0.9% of total consumer consumption. Should AI continue to enhance the value of stocks and other assets, this percentage could grow.
Interestingly, investment isn’t limited to the wealthiest Americans. A recent survey from the BlackRock Foundation and Commonwealth indicated that more than half of Americans earning between $30,000 to $79,999 are now retail investors, with many having entered the market in the last five years. This broadening of the investor base reflects a more engaged middle class in capital markets.
However, it’s important to note the widening economic disparities. Research by Moody’s found that the top 10% of earners accounted for half of all consumer spending in the second quarter, a record high. Through this lens, Michael Brown, a senior research strategist at Pepperstone, highlights two critical trends: the economy’s growing reliance on discretionary spending from higher earners and the risks associated with this dependency on fluctuating wealth.
This evolving landscape emphasizes that both central bankers at the Federal Reserve and policymakers in Congress may have a vested interest in supporting the stock market. The potential for a reverse wealth effect, where declining asset prices dampen consumer spending, underscores the interconnectedness of the equity market and overall economic health. This synergy creates a more resilient structure for risk assets, bolstered by ongoing fiscal stimulus and more accommodating monetary policies. As the relationship between wealth and consumer spending tightens, the implications for economic policy and market strategies will continue to unfold.
