Beer Market for Rescue – Yalla Match

This article is an on-site version of the unprotected newsletter. Register here to send our newsletter straight to your inbox every day of the week

good morning. In response to Friday’s message about the continued strength of the US economy – outside the housing market – the reader made a clear point, which we had to make ourselves. While the economy’s resilience looks good, it will make the Fed’s job harder. You may have to pull very hard to get demand less than supply. But the Fed can hope for help from the markets, as we discuss today. Email us: robert.armstrong@ft.com Email ethan.wu@ft.com.

wealth effects

The bear market in risky assets was caused in part by fears of a recession caused by the Federal Reserve. But causality can also go the other way around: If there is a recession, a bear market is likely to be one of the causes.

Falling stock, bond and cryptocurrency prices make people feel poorer, so they spend less, making the economy smaller than it would otherwise be. For the Federal Reserve, this is welcome news for now. They need to grow to slow down. But how much wealth impact can they expect? Will they get more help than they want?

Desmond Lachman, an economist and fellow at the American Enterprise Institute, noted this in response to a letter last week about the economic slowdown:

The stock market’s nearly 25 percent trail has evaporated about $ 10 trillion of U.S. household wealth. On top of that, at least $ 3 trillion in bonds and $ 2 trillion in cryptocurrency wealth were wiped out due to the defeat in those markets. . . Based on the assumption used by the Federal Reserve that the continued destruction of one dollar’s wealth consumption would decrease by 4 percent, if continued, the recent loss of wealth consumption could decrease by about 3 percentage points of GDP.

This last number found me too big, so I tried to reproduce it. This is what I found:

  • According to distributions to Federal Reserve Bank accounts, US households own $ 42.2 trillion in equities and mutual fund shares by the end of 2021.

  • The Wilshire 5000, an index that captures nearly all publicly traded U.S. equities, has fallen 25 percent since the end of 2021 – a moment that happily coincides with nearly the peak of the market. The Bloomberg Treasury long-term total return index fell by more or less the same amount. Thus, by simplifying the assumptions that (a) Americans are primarily exposed to U.S. equities, (b) Americans get their bond exposure through mutual funds, and (c) the proceeds of this bond exposure roughly follow long-term treasuries, we can assume that lost household portfolios worth $ 10.6 trillion this year.

  • A report by the Federal Reserve examining fluctuations in family wealth and spending during the market boom of the 1990s found that “the groups of families whose portfolios were most strengthened by the exceptional performance of the stock market during the latter half of the 1990s are the same. Groups whose net savings fell sharply from 1995 to 2000, and that ” [resulting] Movements in net worth and savings correspond to a wealth effect in the range of 3-1 / 2 to 5 cents on the dollar that applies to all families in the economy. “

  • So conservatively assume that every dollar lost in the markets amounts to 3.5 cents of lost spending. That equates to $ 370 billion in lost spending, or about 2.6 percent of consumer spending or 1.8 percent of GDP.

  • The total market capitalization of crypto assets has dropped from $ 2.9 trillion to $ 835 billion, according to CoinMarketCap. That equates to a loss of another $ 73 billion in spending, and another third of a percentage or so of GDP.

  • So for a conservative first estimate, the bear market impact on spending could be as much as 2 percent of GDP.

It is very! Remember that GDP grew by 2.6 percent in the first quarter, once you removed some strange fluctuations in inventory and net imports. The consensus of forecasters calls for 1.8 percent GDP growth for the rest of the year, with consumer spending growing slightly faster than that, with the underlying pattern continuing for 2023. How many negative wealth impacts are included in those forecasts? no idea.

However, it is a rough estimate and fairly ready. The sensitivity of spending to loss of wealth probably depends on psychological factors that are difficult to measure. For example, it should be important how many people count on the wealth they have gained in the markets, rather than considering it a windfall. Did households treat their cryptocurrencies as “found funds” rather than hard-earned savings, thus changing their spending patterns less in response to their occurrence and evaporation?

About 20 years ago, Edward Gramlich, a member of the Federal Reserve Board, explained that, in theory, the effect of stock market wealth on consumption must depend on whether stock prices have risen as a result of higher earnings, or because discount rates have fallen (or so to the same, price / earnings multiples increased):

Suppose, for example, that stock prices rise due to higher expected profits, say due to a surge in productivity. The single family that owns shares will have higher wealth and will want to consume more, just as expected from the wealth effect. . .

[if instead] Stock prices rise as families apply lower discount rates to future earnings [then whether] It is not clear in this case that the single family wants to consume more. Intuitively, households simply discount the same stream of earnings at a different rate; It is therefore not clear that they are really better at it and should increase their consumption.

I will intuitively understand this point as follows. If my shares rise due to strong economic growth, the gains make sense to me. I am a growing business owner in a growing economy. If they go up because of the multi-extension, it feels serendipitous. I trust the new wealth less, and may be less likely to let it change my spending patterns as a result.

I’m not really sure if the source of market returns is important for spending or not. But this is a particularly important question at the moment.

During the 2009-2021 bull market, the S&P 500 rose 325 percent (using the end of 2009 as a starting point). Profits during this period increased by 192 percent. The rest of the gains were down to higher P / E ratios of 16 to 24. Much of the recent rise has been brought back (the index is now 18 times above earnings), even with earnings suspended there for the time being. How will household spending patterns respond to a shift in valuation without a large shift in earnings?

good read

If you are reading this newsletter, you will probably be concerned about the Federal Reserve. Most people do not. Could this be a case for inflation expectations?

caution The most important stories from the world of corporate finance. Sign in here

swamp notes Expert insight into the intersection of money and power in American politics. Sign in here

Leave a Comment