How Declining Stocks Could Shake the Backbone of Consumer Spending Today

Diccon Hyatt is a seasoned financial and economics journalist who has extensively covered the evolving economy during the pandemic. With hundreds of articles, he specializes in breaking down complex financial topics into clear insights focused on how economic trends affect individuals' finances and the broader market. His experience includes work with U.S. 1, Community News Service, and the Middletown Transcript.

Essential Insights

• Recent declines in stock markets may reduce consumer spending by weakening the "wealth effect."
• Affluent households, buoyed by years of rising stock prices, have been a major force sustaining U.S. consumer spending.
• Current analyses suggest the "wealth effect" is about four times stronger than usual, meaning falling stocks could cause more significant spending cutbacks.

While political leaders have downplayed stock market drops by emphasizing the "real economy," economists warn that falling stock prices can directly undermine the vital engine of job growth and economic health.

Following a sharp market correction that pushed the S&P 500 into correction territory, U.S. leadership has reassured the public, emphasizing that stock market fluctuations do not necessarily reflect the economy's true state. However, consumer spending — which drives a significant portion of U.S. GDP — is closely linked to stock market performance through the "wealth effect."

Wealthier consumers, who hold a larger share of stocks, have been supporting economic growth by maintaining high levels of spending. Data from Moody’s Analytics indicates that the top 10% of earners account for nearly half of all consumer spending, the highest proportion recorded since 1989.

Understanding the Wealth Effect

The "wealth effect" describes the tendency for people to spend more when their perceived wealth increases, often influenced by rising asset values like stocks.

Because affluent households are more invested in the stock market, a significant sell-off can prompt them to reduce spending. This reduction can ripple through the economy, leading to slower hiring and decreased incomes, thereby impacting the "real economy" of jobs and consumption.

Oxford Economics highlights that the wealth effect's impact on consumer spending is currently four times greater than normal, making the economy more vulnerable to stock market downturns.

Recent months have shown signs of weakening consumer spending, with retail sales dropping sharply in January and only modest recovery afterward.

Ryan Sweet, chief economist at Oxford Economics, notes, "If the stock market decline continues, it will likely dampen consumer spending. Household net wealth now plays a larger role in spending decisions than before. While a strong wealth effect has boosted spending, it could equally become a major drag in a bear market."

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