Wealth effect stock market recession

Stock market growth that seems impervious to tariffs, politics, and a moribund jobs picture is in turn powering consumer spending and putting a floor under an economy that many expected to be teetering on the brink of recession by now. Economic data this week painted a surprisingly bright picture of recent trends. Consumer spending in August was stronger than expected, as was income. Companies and households continue to order big-ticket items while inflation has been relatively soft. Even housing showed signs of life, with new sales hitting a three-year high in August.

Previously, such trends had been powered by trillions in stimulus from both congressional spending and low-interest rates and liquidity injections from the Federal Reserve. But the narrative now is shifting towards the ever-popular wealth effect coming from Wall Street and a succession of new highs in major stock indexes despite lofty valuations.

“I do think that goes to the bounce in the stock market and the wealth effect,” Mark Zandi, chief economist at Moody’s Analytics, said Friday on CNBC. “I think all of the spending is coming from the well-to-do high-income high-net-worth households that are seeing their stock portfolios are up and they’re feeling a lot better off and they’re spending.”

Indeed, the market has seen a stair-step climb higher this year, boosted by massive AI spending, no doubt, but also rallying thanks to strength in big industrial companies and communications giants. The Dow Jones Industrial Average has gained more than 9%, while the tech-focused Nasdaq Composite is up 23%.

Consumers are almost always happier when stocks are up and unemployment is low, as is currently the case. However, sentiment this year as measured by the University of Michigan has been in a steady decline, falling 23% since January when President Donald Trump took office. The Michigan gauge fell 5.3% in September, though survey Director Joanne Hsu noted an anomaly: “Sentiment for consumers with larger stock holdings held steady in September, while for those with smaller or no holdings, sentiment decreased.”

That makes sense considering the stock market has set a succession of new records this month. Being that the top 10% of earners in the U.S. own 87% of the market, according to St. Louis Fed data, asset holders have reason to be pleased. That’s also, according to Zandi, a reason why the economic strength could be built on sand.

“The economy’s very vulnerable if the stock market does turn south, for whatever reason,” he said. “People start seeing red on their screens and not green on their screens and the savings rate goes up not down. In the current context of no job growth, that’s a recession.”

Concerns over the stock market primarily focus on valuations, with the S&P 500 currently trading at 22.5 times expected earnings for the next 12 months, well above both the five- and 10-year trends, according to FactSet. For all that, recent economic data indicates few recession pressures. Consumer spending in August increased 0.6%, according to Commerce Department numbers released Friday that were better than expected. Spending adjusted for inflation rose 0.4%, indicating consumers are still able to weather price increases. On inflation, the annual rate is still well in excess of the Fed’s 2% target, with core holding at 2.9%.

The Federal Reserve is on track for a rate cut in October, with another possible cut in December, as monthly increases remain in line with previous trends and Wall Street forecasts. Despite the negative sentiment expressed in surveys and by commentators, the economy has been surprising to the upside, with consumers continuing to spend and corporate profits exceeding expectations.

Chief Investment Officer Chris Zaccarelli from Northlight Asset Management noted that actions speak louder than words, pointing to the strength of consumer spending as a driving force behind the economy’s stability. This sentiment was echoed by senior economist Elizabeth Renter from NerdWallet, who highlighted the resilience of consumers in keeping the economy strong despite challenges like inflation and uncertainty.

Recent economic data has also been positive, with GDP growing at a 3.8% annualized pace in the second quarter and consumer spending outperforming expectations. Durable goods orders increased unexpectedly, new home sales surged by 20%, and jobless claims remained low. The Atlanta Fed raised its GDP tracking estimate for the third quarter, indicating a strong growth rate of 3.9%.

However, Renter cautioned that the economy is on a knife’s edge, with a significant portion of consumers not participating in the stock market gains and overall sentiment levels reflecting concerns about a potential recession. While investors have been largely doing well, there is a sense of unease among consumers due to factors like inflation and labor market weakness.

Overall, the economic outlook remains positive, with consumers driving growth and key indicators pointing towards stability. The Federal Reserve’s anticipated rate cuts are seen as a response to the current economic environment, aiming to support continued growth and mitigate potential risks. As the economy navigates through uncertainties, the resilience of consumers and the strength of key economic indicators will be crucial in shaping future outcomes.