Does a rising stock market increase consumer spending? Said differently, how relevant is what happens on Wall Street to what average Americans do on Main Street? It clearly hasn't slowed this year's impact to the commercial real estate and retail sectors.
It’s a perennial question, one which tends to surface during political debates, as the champions of corporate tax cuts and deregulation (usually, though not always, Republicans) lock horns with those who denounce “income inequality” and corporate greed (usually, though not always, Democrats). Those debates, muddied as they are by partisanship, never seem to settle the issue. Similarly, the opinions of economists, though arguably more reliable, are so nuanced and peppered with insider jargon that the rest of us are left asking, “What did they just say? Is the answer yes or no?”
What’s the Empirical Evidence?
Has anyone ever studied the relationship between a rising (or falling) stock market and retail spending, and have they come to any conclusions? The simple answer is, “yes.” Published in 1998 by the Federal Reserve Board of Governors, “Stock Market Wealth and Consumer Spending” concludes that what happens in the stock market does, in fact, influence consumer spending, but then adds an important caveat:
“Traditional macroeconometric models estimate that a dollar's increase in household wealth boosts consumer spending by 3 to 7 cents per year. Such an effect is consistent with predictions from a simple lifecycle model, in which consumers spend more over their lifetimes in response to higher wealth.”
That’s a mouthful, so let’s unpack it. When the stock market goes up, consumer wealth increases. “Wealth” as defined by the Fed, however, doesn’t mean simply how much you have in your checking account or your wallet. It also includes the value of your home and how much you have in your retirement account. Said differently, changes in the stock market have a nominal effect on annual consumer spending, but a more substantial impact on how much consumers spend over the course of their lifetimes.
What Happens When the Stock Market Changes Suddenly and Dramatically?
It’s true that the stock market crash of 1929 preceded the Great Depression. It’s also true, however, that the stock market crash of 1987 (during the Reagan administration) influenced monetary policy, but had little if any perceptible impact on the overall economy or retail spending. In fact, most economists agree that the stock market is a notoriously poor predictor of recessions, or of consumer spending.
As Bob Bryan, a policy reporter for Business Insider, notes in “The Stock Market Is Terrible at Predicting Recessions:”
“‘Did you know that the stock market has predicted 27 of the past 11 recessions?’ Gluskin Sheff's David Rosenberg quipped on Friday. If you're more statistically inclined, Ian Shepherdson of Pantheon Macroeconomics ran a regression for stock market performance and GDP. Spoiler alert: They aren’t very correlated.”
What about Consumer Confidence?
Consumer confidence is a measure of how optimistic consumers are about the state of the economy—and there does appear to be a correlation between the stock market and how confident consumers are (and, by extension, how likely they are to spend their money). For example, in the aftermath of the most recent Presidential election, the stock market shot up, and consumer confidence went up with it, from 87.2 before the election to 98.5 by the end of January.
Here too, however, there’s an important caveat. Although the stock market continued to rise through the end of June, consumer confidence began to drop (to 94.5) after the new administration seemed unable to achieve some of its key economic objectives, like cutting taxes, “repealing and replacing” the Affordable Care Act and spending big on infrastructure. In other words, the stock market is one factor which influences consumer confidence, but it's not the only one. So far, a booming market and robust consumer confidence hasn't been based on wage growth and that has economists concerned. Fading optimism would result in less spending, interest rates will remain relatively low and the stock market will continue to outperform bonds, feeding the Wall St., engine, but not translating to the foundation for long-term growth.
Does That Mean Wall Street Is Irrelevant to Main Street?
The consensus among economists is that changes in the stock market do not appreciably affect retail spending in the short term. That doesn’t mean, however, that what happens on Wall Street is irrelevant to the shops on Main Street—but the impact is subtle, and often difficult to trace.
If you have a pension fund, that means you’re invested in the stock market, and that when stock prices drop, your retirement fund loses value. That could make you focus more on savings than spending, and that can affect Main Street. Similarly, the stock market can affect the housing market, and the value of your home, like that of your pension fund, can affect your spending habits.
The bottom line is that if you own a business—whether it’s a brick and mortar store or an ecommerce business—you can’t depend on external factors like what’s happening on Wall Street to achieve your primary business objectives. Brands and retailers who differentiate themselves with innovation toward great products and service will generally have a market that can help them ride out the rollercoaster of Wall St.