Stock market expansion that appears resistant to tariffs, political issues, and a sluggish employment scenario is in turn fueling consumer expenditure and stabilizing an economy that many anticipated would be on the verge of recession by now.
This week’s economic indicators revealed an unexpectedly optimistic view of recent developments.
Consumer spending in August outperformed expectations, and income figures were also favorable. Businesses and households persist in making purchases of expensive items, while inflation remains relatively tame. Even the housing sector showed improvement, with new home sales reaching a three-year peak in August.
Previously, these trends were fueled by trillions in stimulus from congressional expenditures, low-interest rates, and liquidity provisions by the Federal Reserve.
However, the narrative has begun to pivot towards the ever-favoured wealth effect stemming from Wall Street and a series of record highs in major stock indexes despite high valuations.
“I believe this is related to the stock market’s rebound and the wealth effect,” Mark Zandi, chief economist at Moody’s Analytics, remarked on CNBC on Friday. “All the spending appears to be originated from affluent households that are observing an uptick in their stock portfolios and feeling more financially secure, which is driving their expenditures.”
Indeed, the market has experienced a gradual ascent this year, bolstered by significant AI investments, but it also owes its momentum to robust performances from leading industrial firms and major communication entities. The Dow Jones Industrial Average has risen over 9%, while the tech-centric Nasdaq Composite has climbed 23%.
Consumers are generally in a better mood when stock prices rise and unemployment remains low, as it is currently. Nonetheless, overall sentiment this year, as reported by the University of Michigan, has shown a continuous decline, decreasing 23% since January when President Donald Trump took office.
A double-edged sword
The Michigan index dropped 5.3% in September, although survey Director Joanne Hsu observed a noteworthy detail: “Sentiment among consumers with larger stock holdings remained stable in September, while those with smaller or no investments noted a decline.”
This is understandable, considering the stock market has achieved multiple new highs this month. Since the top 10% of earners in the U.S. own 87% of the market, according to St. Louis Fed data, those with assets have reasons to feel satisfied.
This condition may also explain, as noted by Zandi, why the strength of the economy might be precarious.
“The economy could be very precarious if the stock market declines for any reason,” he stated. “People notice red on their screens instead of green, and their savings rate increases instead of decreases. In the current environment of stagnant job growth, that signals recession.”
Concerns surrounding the stock market primarily revolve around valuations, with the S&P 500 currently trading at 22.5 times anticipated earnings for the next 12 months, significantly exceeding both the five- (19.9) and 10-year (18.6) averages, according to FactSet.
Despite that, recent economic indicators show minimal recessionary pressures.
Consumer spending in August rose by 0.6%, reflecting better-than-expected figures from the Commerce Department released on Friday. Inflation-adjusted spending increased by 0.4%, suggesting consumers are managing well amid rising prices.
On the inflation front, the yearly rate remains well above the Fed’s 2% target, with the core rate holding at 2.9%. However, monthly increases are largely in line with prior patterns and Wall Street forecasts, placing the Fed on a clear path towards an October rate reduction and potentially another in December.
“The economy has consistently defied expectations positively, and despite the pessimism reflected in various surveys and echoed by analysts, actions speak louder than words; consumers continue to spend, which is why corporate earnings keep surpassing projections,” stated Chris Zaccarelli, chief investment officer for Northlight Asset Management.
More good news, more danger
There were additional positive economic developments this week as well.
Gross domestic product experienced a 3.8% annualized growth rate in the second quarter, based on a revision on Thursday that was half a percentage point higher than prior estimates. Once again, the main driver for the upside surprise was significantly stronger consumer spending than previously considered. Moreover, the Atlanta Fed raised its GDP tracking estimate for the third quarter, elevating the growth projection to 3.9%, which is 0.6 percentage points higher than the previous update a week ago.
Additionally, durable goods orders rose unexpectedly, while new home sales surged by 20%. This followed a brief spike in jobless claims from a couple of weeks ago, which turned out to be an anomaly, with layoffs remaining low, though payroll growth has been relatively flat at best.
Even if consumers at the higher end are mainly driving the expansion, the macroeconomic data at least depict a narrative of stability.
“Often, when individuals feel pessimistic about the immediate future of the economy, they start curbing expenditures, but that has not been the situation thus far,” remarked Elizabeth Renter, senior economist at consumer site NerdWallet. “In reality, the resilience of consumers is credited with sustaining the economy’s strength over the last few years, despite high inflation, elevated [interest] rates, and substantial uncertainty.”
However, Renter also highlighted the precarious position of the economy, with a large segment of consumers not participating in the stock market improvement and thus feeling dismal, while overall sentiment levels align with recessionary conditions.
“Wealth offers some buffer against perceived economic volatility, and investors have generally fared well,” she noted. “Consumers are acutely aware of the existing economic risks — inflation and job market vulnerabilities. This could stem from personal experiences — food prices spiked significantly last month — or from anxiety caused by headlines tracking essential economic data. Regardless, people are not feeling optimistic about the economy, their role within it, or the direction it is headed.”
