Market drop could hurt consumer spending

Economy, Wall Street ‘are tied at the hip’

Michelle Cowherd, 56, of Houston, has seen her retirement savings grow by $400,000 the past two years as stocks soared and her home value increased $20,000 to $30,000. As a result, she and her husband, Terry, are planning trips to Asia and Europe this year — and a cruise.

“It gives you a lot more confidence,” she says.

But with the recent market turmoil, Cowherd’s portfolio fell by $13,000 one day, so she’s considering postponing the European vacation. “I’m watching the market. If I keep losing (substantially), I’m not taking the trip,” the retired environmental engineer says.

Through the market’s recent drop, financial advisers, economists and financial media stars pointed to the strong economy’s support of corporate earnings as theoretically limiting the size of any decline.

Here’s the problem: A market fall itself could hobble consumer spending, a chief growth engine, if it deepens, undercutting the healthy economy. That could create a toxic feedback loop between stocks and the economy.

The link between the two is particularly strong because sharply rising stock and home prices have juiced

consumer spending since the recession ended in 2009, a dynamic known as the wealth effect, according to a new study by Moody’s Analytics, Visa and Equifax. As a result, even a partial reversal of the

9-year-old bull market, if it’s sustained, could prompt many people to pull back. Consumption makes up 70% of economic activity.

“The economy is tied at the hip to the stock market,” says Mark Zandi chief economist of Moody’s Analytics. Even a

10% market retreat would noticeably curtail spending and economic growth, he says.

“If we were to see a sustained bigger drop (of about 20%), that would really sap a lot of the spending” that has fueled the recovery, says Visa Chief Economist Wayne Best. “While that’s not the most likely scenario, it certainly bears watching.”

It’s too early to expect recent market volatility to dampen spending, Zandi says. Wealth effects typically work with a lag of a year or more as investors become convinced that market changes are long lasting. But stock gains since

2009 have had some impact on spending in as little as three to six months, according to the study, which analyzed spending patterns in hundreds of cities. And some Americans are at least thinking about modifying plans, pending market movements in coming weeks and months.

The long-term picture has been bright. Stocks are up 20% the past 18 months even after the recent sell-off and 300% since their 2009 bottom, according to the Moody’s study and the Wilshire 500 index. Home prices have risen 40% since their 2011 low. Household net worth, in turn, hit a record

$97 trillion in the third quarter, Federal Reserve figures show.

Every dollar increase in wealth boosts spending by 3 cents, the study says, while a dollar decline reduces spending by 5 cents, suggesting that a large market drop could take a bigger toll on spending as Americans fret about shrinking nest eggs. These effects are about double the historical norm, Zandi says, because of the market’s strong and steady surge in recent years.

All told, the wealth effect has accounted for a quarter of consumer spending growth since 2009 and a third of the gains the past year, the study says. Consumer spending increased a solid 2.7% in 2017.

“The U.S. stock market has been jet fuel for the recovery,” Zandi says.

Bigger purchases are most influenced by the wealth effect, such as airline fares, hotel stays and furniture, the study found. Clothing and restaurants are moderately affected. And the impact is minimal for necessities such as groceries and drugstore items.

The effects of increased wealth on spending can be seen most starkly in the share of income Americans save. The savings rate fell to 2.6% in the fourth quarter, near its all-time low of

2.2%, from 6.2% in 2015 as swollen retirement accounts made consumers confident enough to spend more of their paychecks.

Richer households have been most emboldened. From 2009 to 2017, the savings rate fell from 19.2% to 11.9% for the top 5% of income earners, but it rose for other groups, the study shows. About half of Americans own stock directly or through mutual funds or retirement accounts, but only about

20% realize significant benefits that have bolstered spending, Zandi says.

By contrast, about two-thirds of Americans, including many middleincome workers, own homes. That’s why the study found that rising home prices have a bigger impact than stocks on spending. The past two years, stock wealth has leaped by

$7 trillion while home values have increased $2.5 trillion. But middle-income households tend to spend more of their profits than the wealthy, Visa’s Best says.

It’s a market downturn, however — spurred by fears of rising inflation and interest rates — that has economists worried. A 10% drop in stock prices would shave seven-tenths of a percentage point off growth (in an economy projected to grow 2.5% this year and 2.1% in 2019), while a 20% dive could tip the economy into recession, the study says.

Fortunately, the 4.1% unemployment rate is likely to boost wage growth this year, Point72 Asset Management Chief Economist Dean Maki says, and the Republican tax cuts should increase disposable income. Those factors should at least partly offset negative fallout from a shaky market and higher inflation, he says.