The advancement of the stock market, which appears resistant to tariffs, political issues, and a stagnant job situation, is simultaneously driving consumer expenditure and bolstering an economy that many anticipated would be on the verge of recession by now.
This week’s economic reports revealed an unexpectedly positive view of recent developments.
Consumer spending in August exceeded expectations and income levels did too. Both companies and households are continuing to purchase major items while inflation remains relatively mild. Even the housing sector showed revitalization, with new home sales reaching a three-year peak in August.
In the past, such patterns were fueled by trillions in stimulus from congressional spending along with low interest rates and liquidity infusions from the Federal Reserve.
However, the focus is now shifting towards the widely-discussed wealth effect stemming from Wall Street, along with a series of new peaks in key stock indexes despite high valuations.
“I believe this is related to the rebound in the stock market and the wealth effect,” commented Mark Zandi, chief economist at Moody’s Analytics, on Friday during an appearance on CNBC. “I think all the expenditure is being driven by affluent high-income, high-net-worth households who see their stock portfolios increasing, leading them to feel significantly better off and to spend.”
Indeed, this year the market has experienced a stepwise ascent, propelled by substantial AI investments, of course, but also buoyed by the robustness of leading industrial firms and telecommunications behemoths. The Dow Jones Industrial Average has risen over 9%, while the tech-centered Nasdaq Composite has climbed 23%.
Consumers tend to be happier when stock prices rise and unemployment is low, which is currently the case. However, this year’s sentiment as tracked by the University of Michigan has shown a continuous downward trend, dropping 23% since January when President Donald Trump assumed office.
A double-edged sword
The Michigan indicator decreased by 5.3% in September, although survey Director Joanne Hsu pointed out a peculiarity: “Sentiment among consumers with larger stock holdings remained stable in September, while those with smaller or no holdings experienced a decline.”
This is understandable given that the stock market has achieved multiple new highs this month. With the top 10% of earners in the U.S. possessing 87% of the market, according to data from the St. Louis Fed, asset holders have cause for contentment.
According to Zandi, this is also a reason why the economic foundation might be precarious.
“The economy is very susceptible if the stock market declines for any reason,” he stated. “As soon as people start seeing red instead of green on their screens, the savings rate will climb rather than fall. In the currently stagnant job growth context, that signals recession.”
Concerns surrounding the stock market are mainly centered on valuations, with the S&P 500 currently trading at 22.5 times the anticipated earnings for the next year, considerably higher than both the five- (19.9) and 10-year (18.6) averages, as per FactSet.
Despite this, recent economic indicators reveal minimal recessionary pressures.
Consumer spending in August rose by 0.6%, according to Commerce Department figures released on Friday, which exceeded expectations. Spending adjusted for inflation increased by 0.4%, suggesting that consumers maintain their ability to withstand price hikes.
Regarding inflation, the yearly rate remains significantly above the Fed’s 2% target, with core inflation at 2.9%. However, monthly increases align with prior trends and Wall Street predictions, likely positioning the Fed for an interest rate cut in October and potentially another at its December meeting.
“The economy continues to exceed expectations and in spite of the pessimism found in surveys and expressed by analysts, actions are more telling than words, and consumers persist in spending, which is why corporate profits keep surpassing predictions,” stated Chris Zaccarelli, chief investment officer for Northlight Asset Management.
More good news, more danger
This week produced additional positive economic developments.
The gross domestic product expanded at a 3.8% annualized rate in the second quarter, according to a revision on Thursday that was 0.5 percentage points higher than initially estimated. Once again, this uptick was largely due to consumer spending being significantly stronger than the prior estimate. Furthermore, the Atlanta Fed revised its GDP tracking estimate for the third quarter, raising the expected growth rate to 3.9%, or 0.6 percentage points higher than the previous update from a week ago.
Additionally, durable goods orders unexpectedly rose, while new home sales soared by 20%. This came after an increase in jobless claims a few weeks prior turned out to be a minor fluctuation, with layoffs remaining low, although payroll growth has been stagnant at best.
Even if growth is primarily driven by higher-end consumers, the macroeconomic data conveys at least a narrative of stability.
“Often, when individuals feel negative about the near-term economy, they start to limit spending, but that hasn’t happened so far,” stated Elizabeth Renter, senior economist at consumer site NerdWallet. “In fact, the resilience of the consumer is credited with keeping the economy robust over the past several years, despite high inflation, elevated [interest] rates, and significant uncertainty.”
However, Renter also remarked on the precarious balance the economy maintains, with a wide range of consumers not participating in the stock market enthusiasm and thus feeling pessimistic, and overall sentiment levels aligning with recession indicators.
“Wealth offers some buffer against perceived economic instability, and investors have generally been faring well,” she noted. “Consumers are aware of current economic risks — both inflation and weaknesses in the labor market. This awareness may stem from personal experiences — as food prices surged last month — or from anxiety generated by news tracking key economic indicators. Regardless, people are not feeling positive about the economy, their standing within it, or its future trajectory.”
