After a big rally or sell-off, people often point out that the stock market is not the economy, or that Wall Street is not Main Street. But the divide is becoming increasingly blurred.
That’s because higher asset prices are stimulating consumers to spend more freely than before, and consumption accounts for about 70% of GDP. In fact, this so-called wealth effect has become even more powerful over the past 15 years.
Today, every 1% increase in stock wealth is associated with a 0.05% increase in consumer spending, according to a report last week by Bernard Yaros, chief U.S. economist at Oxford Economics.
In other words, for every $1 increase in stock wealth, the marginal propensity to consume increases by $0.05, up from less than $0.02 in 2010. At the same time, every $1 increase in housing wealth leads to an increase in consumption of $0.04, compared with $0.03 in 2010.
“As household wealth increases, they become more optimistic about their personal finances and more inclined to loosen their wallets,” Yaros wrote. “Increased wealth will also drive spending by allowing homeowners to withdraw more equity from their homes or liquidate appreciating stocks to fund current consumption.”
He believes the wealth effect will lead to a higher marginal propensity to consume in future years because retirees will make up a larger share of the population.
Yaros explained that given that retirees already have more net worth than younger generations, they will rely more on their wealth to support consumption after they stop working and earning income.
On top of that, he adds, the ubiquity of digital media means consumer sentiment responds even faster to market news, reinforcing these wealth effects.
This stronger wealth effect may help explain why Consumer spending remains resilient. Even as President Donald Trump’s trade war keeps inflation sticky and makes businesses more nervous about adding workers amid uncertainty, artificial intelligence is still driving stocks to new all-time highs.
At the same time, the stock market has become increasingly dependent on artificial intelligence-related stocks, such as chip leaders NVIDIA and so-called hyperscalers, e.g. Microsoft and Google.
Based on his Wealth and Spending calculations, Jarosz estimates that the stock market rally driven by the tech sector alone will drive nearly $250 billion in annual spending over the past 12 months, which would account for more than 20% of cumulative spending growth.
“While the stock market is not the economy, the ups and downs of the economy can have a bigger impact.
The former,” he wrote.
Analysts at JPMorgan Chase also examined the connection between the AI craze and consumers in a report last month. They estimate that U.S. households gained more than $5 trillion in wealth from 30 AI-related stocks last year, adding about $180 billion to their annualized spending levels.
That represents just 0.9% of total consumption, but JPMorgan noted it could be higher if AI spurs gains in broader stocks or other assets such as real estate.
Stocks aren’t just for wealthy Americans, either. one A survey released last month by the BlackRock Foundation and the Commonwealth Research shows that more than 54% of Americans with an annual income of US$30,000 to US$79,999 are retail investors in the capital market. More than half of them started investing in the past five years.
To be sure, the richest still spend the most dollars, and the emerging K-shaped economy amplifies their impact. Moody’s research found that the top 10% of earners accounted for half of all spending in the second quarter, a record high.
Michael Brown, senior research strategist at Pepperstone, attributes this to the wealth effect of stock and real estate gains and income disparity.
“Putting all this together creates two things: the economy increasingly relies on discretionary spending by high earners, and discretionary spending by high earners relies on continued activity in risk assets,” he said in a note on Tuesday.
Brown added that this dynamic means that central bankers at the Federal Reserve, who control monetary policy, and members of Congress, who control fiscal policy, have greater incentives to support stocks.
This is because the wealth effect can work in reverse, meaning falling asset prices will slow spending and economic growth.
“What we have, then, is an economy that is increasingly tied to the fortunes of the stock market, and a stock market that is increasingly tied to overall consumer spending, which combined has led to a stronger ‘bearish’ structure to support risk assets, with fiscal stimulus continuing and the monetary backdrop becoming looser,” he said.