Every $1 Change in Financial Wealth Moves Spending by 14 Cents: Oxford Economics Study

The adage “the stock market isn’t the economy” has been a mantra for economists and market analysts alike, suggesting that fluctuations in stock prices do not directly translate to the economic wellbeing of everyday people. However, recent findings from Oxford Economics challenge this notion, revealing that movements in equities and other financial assets increasingly play a significant role in shaping consumer sentiment and spending behavior. Bernard Yaros, the lead U.S. economist at the research firm, emphasized the impact of financial wealth on consumer spending in a note published Thursday.

The Wealth Effect: A Key Playing Field

The wealth effect describes the phenomenon wherein changes in perceived wealth—whether through rising stock prices, home values, or other financial assets—can have a pronounced effect on consumer spending patterns. According to Yaros, households are accumulating wealth at an accelerated pace compared to previous economic expansions, leading to a significant boost in consumer spending. “All told, the overall wealth effect owing to financial assets and real estate is about as large as it’s ever been,” he stated.

Quantifying the Wealth Effect

Oxford Economics has highlighted that the impact of financial wealth is substantial. The research specifically focused on different types of financial wealth, such as stocks, bonds, mutual funds, cash, and pension entitlements, along with housing wealth. The empirical analysis yielded an estimate that for every 1% change in financial wealth, personal consumption expenditures (PCE) move by approximately 0.14%. In simpler terms, this means that any $1 change in financial wealth correlates with a 14-cent adjustment in consumer spending as captured by the PCE, which gauges total spending by individuals and households on goods and services.

A Shift in Wealth Dynamics

In another striking revelation, Oxford Economics found that the influence of financial wealth—partly through stock markets—now surpasses that of housing wealth in stimulating spending. Historically, the financial wealth effects were overshadowed by those of housing, particularly during the tumultuous period of the 2007-2009 financial crisis. However, once stocks regained their pre-crisis values in 2013, they began asserting dominance over housing wealth effects, suggesting that post-crisis, households have become increasingly confident in the wealth generated by stock markets rather than relying solely on property values. Yaros noted, “this shift indicates that households began trusting the wealth created by stock markets more than housing.”

Potential Risks of Market Corrections

Despite the buoyant outlook on wealth and spending, the recent fluctuations in stock prices deserve attention. The S&P 500 index recently posted a record closing value on February 19 but has since experienced a pullback, dropping into correction territory—defined as a decline of 10% from a recent peak. Oxford Economics predicts that if this downward trend persists and reaches a 20% drop, signaling a bear market, it could negatively impact PCE by 0.3 percentage points this year. While this reduction may seem modest on the surface, the implications for specific sectors could be severe.

Vulnerability of Discretionary Spending

Some consumer spending areas may experience a pronounced impact due to the potential wealth effect. Sectors like recreational goods and services, as well as vehicle purchases, could witness declines exceeding 0.3%. Additionally, discretionary spending in air travel, rental vehicles, restaurants, and hotel services would likely face pressure. Yaros warns that these spending categories are not only dependent on wealth but are also sensitive to shifts in consumer sentiment, which has recently waned due to uncertainties stemming from President Donald Trump’s tariff policies. This creates a precarious situation where lower stock prices and weakened consumer sentiment could strike a “double whammy” on discretionary spending.

A Growing Wealth Effect Amid Changing Demographics

As targeted spending reveals heightened sensitivity to stock market performance, the implications of such trends are multifold. The increasing wealth effect, noted Yaros, is consistent with the demographic shift towards a growing population of retirees. These individuals, who generally have higher net worth but rely more heavily on income generated from existing wealth rather than wages, are more impacted by variations in their financial portfolios. Furthermore, their consumer expectations are more closely associated with stock market fluctuations than with real estate markets.

Conclusion

The growing centrality of financial wealth in determining consumer spending indicates a complex relationship between market dynamics and economic behavior. As accumulated assets begin to dictate consumer confidence and expenditure, understanding this evolving landscape becomes critical for policymakers and analysts seeking to navigate future economic challenges.