The Wealth Effect: Do you feel it?
With the fresh stock and real estate market highs as well as consumer spending continuing to accelerate, we must ask, is there a “wealth effect” in play? The “wealth effect” refers to an increase in consumer spending that is relative to portfolio performance such as strong markets in real estate and stocks. Simply put, when a person’s investments go up they just feel “wealthier” and that leads to more consumption from consumers. When looking at its importance and far-reaching effects, it may surprise you!
The Wealth Effect’s Importance
Researchers determined that for every dollar of increase in stock market wealth, there is a 2.8 % rise in consumer spending per year. In addition to greater consumer spending, a rise in stock market wealth correlates with increases in local employment and payrolls. How significant is this? A recent study determined that GDP growth from 2008-2016 was close to 2.2% per year. The wealth effect was solely responsible for almost half a percent of that per year.
A recent study states that an increase in home value has generally had a larger effect on consumer spending then financial wealth. From 2016-2018 home prices increased by 12% which equates to an increase in housing wealth of $2.5 trillion. Certainly significant! The same study cited home improvement as one of the largest categories for increased spending. Similarly, while increased consumer spending is certainly a positive for the U.S. economy, we must remember that considerable decreases in real estate and stock market wealth can also lead to lower consumer spending and overwhelm the positive trends we currently see.
We expect that this could be a big year for the housing market because of the stock market gains. Why? Just as a prudent gambler who should cash out when having an incredible winning streak, people may indeed “cash out” some of their investments to purchase a home or want to upgrade and buy a new home.
However, as I am sure you know, economic headwinds are unpredictable. And while the United States’ subprime mortgage crisis was the first chapter of the 2008 financial crisis, it appears housing will instead be the final chapter in this economic expansion. Just like musical chairs when the music stops—and it eventually always does—this time it might be best that your money be in your chair/home rather than keeping it all in the market.
From the trenches,