U.S. Federal Reserve Chairman Jerome Powell speaks during a press conference in Washington D.C. … [+] (Photo by Liu Jie/Xinhua via Getty)
Xinhua News Agency/Getty Images
Despite significant asset price rises, there is little discussion about the “wealth effect.” It is the natural and powerful impact on consumer confidence, spending and investing – at least, for those who own stocks and housing.
In past periods of significant stock price gains or home price rises, the wealth effect has been an important and popular discussion subject. But not today, even though there is an unusual combination of significant price gains for both asset classes.
Instead, the focus remains on the Federal Reserve’s easy money policies and the federal government’s economic support and growth spending. The house price gains are viewed as Covid recovery plus limited supply. And the stock price gains are viewed as proof of business recovery and economic growth ahead.
There are serious problems caused by neglecting the repercussions of a strong wealth effect.
- First, inequality is heightened. Stock investors and homeowners benefit as others are left behind. In fact, non-stock holders are made worse-off by below-inflation interest rates (i.e., negative “real” yields). And non-homeowners must contend with rising rent payments.
- Second, higher inflation is aided. The wealth effect provides the optimism and potential funds to increase demand – for both additional investing and consumer spending. The latter action is what helps boost price levels (inflation).
The housing market price boom
The best way to see how extreme the house price rises have been is to look at the longer-term picture. This graph shows both existing and new home prices from 1990. It makes clear the huge impact of the Great Recession’s preceding subprime-house bubble.
Existing home vs new house pricing – unadjusted
John Tobey (FRB of St Louis – FRED)
The excess housing inventory created by the bubble and the recession took a long time to be liquidated. Now, the tide has turned, with prices rising due to limited supply. Or, at least, it appears to be so. To understand better what is happening, we need to first take inflation out of the picture. Those previous home prices are in dollars of different value (purchasing power). Here’s how the real price changes look, adjusted for CPI (excluding volatile food and energy prices).
Existing home and new house pricing – inflation adjusted
John Tobey (FRB of St Louis – FRED)
Now the real growth periods in home prices are visible. Note especially the lack of long-term price growth. That makes this period’s rapid price rise suspect. Also note the now-higher level of existing home prices compared to new house prices. That was a symptom of the previous “great” housing bubble. Also, note that even after adjusting for inflation, today’s median existing home price now exceeds the peak bubble prices.
The stock market price boom
Nothing says, “happy days are here again,” like the stock market. Steadily up, with even the enormous $1 T companies now nearing and crossing the $2 T mark. Why? Covid unexpected benefits and recovery extrapolated into superior future growth expectations. So, is exceptional growth ahead?
Well, sure, is we presume optimism and hopes are fulfilled. This quarter’s expected “fabulous” earnings reports were believed to be the first giant step. While they have been good, stock price reactions have generally been lackluster. Those reactions indicate investors already expected better-than-forecast earnings, so anything less than exceptional produced little oomph.
Most of the meaningful June quarter earnings reports are in. For the Dow Jones Industrial Average’s 30 companies, 22 of the 24 have reported (Walt Disney
DIS
and Amgen
AMGN
are the two remaining). The other six have different quarter-end dates: July for Home Depot
HD
, Walmart
WMT
, Cisco and Salesforce
CRM
; August for Walgreens
WBA
and Nike
NKE
. So, where does that leave the stock market, especially now that several economic indicators (including GDP) recently came in below expectations?
There are two major items investors can look forward to.
First is the post-Labor Day Wall Street “tradition” of ramping up focus on the next year – 2022. Economy and company growth has long been expected to be good (even excellent) then. That raises the questions of whether the optimism is already in the market (likely so) and, following, whether it will ramp up or be tempered.
Second is the September earnings report period starting in mid-October. They will lock up summer results and move reality into the fall period. Will high growth proof be the result? If so, that will be good support for the optimism about 2022.
As to where the market stands now, once again the best view is the longer-term picture. Here, for the 1990-2021 period, are the inflation-adjusted results of the entire U.S. stock market (Wilshire) and the growthier stocks in both the Nasdaq Composite Index and the large company Nasdaq 100 Index.
Stock market indexes from 1990, adjusted for inflation
John Tobey (FRB of St Louis – FRED)
Obviously, the stock market over time has delivered real returns that far exceeded inflation. To show the relative growth rates during the 30+ year period, the next graph uses a logarithmic scale. (For example, the scale changes so the vertical distance of a 100% gain from 100 to 200 equals a 100% gain from 200 to 400.) Importantly, note that the past year’s growth rate exceeds the 2010-2019 period’s growth rate.
Stock market indices, adjusted for inflation, on a log scale
John Tobey (FRB of St Louis – FRED)
A final graph shows the Nasdaq 100 as reported (not inflation-adjusted) from January 2010 through July 2021. The faster growth rate shows clearly, speeding up the wealth effect from stock ownership.
Nasdaq 100 Index (unadjusted) on log scale 2010-2021
John Tobey (StockCharts.com)
The bottom line: From rapid “inflation” of asset values will come faster consumer price inflation
When that happens, there will be serious, uneven results that come out of that link.
On the winning side are investors and homeowners. Also benefiting are organizations and individuals in ancillary positions (e.g., commission-based realtors and option-holding executives.) Increased inflation? Higher level employees will be covered, particularly in organizations that can raise prices without adversely affecting sales.
On the losing side are consumers and renters. Also harmed by the link to higher inflation are those receiving fixed amount annuity payments or relying on fixed income securities. Then there are the multitudes whose pay will not keep pace with inflation.
The one other, very negative fallout of higher inflation will be the Federal Reserve’s inability to keep rates near zero. The first crack will be the loss of control over longer-term bonds as Wall Street reasserts its historic capitalism role . In past inflationary periods, yields easily rose to 5% and higher to compensate for higher inflation and provide a real return of around 1% to 2%.
When that happens, expect many other actions and reactions that have not been seen for many years – some positive, many negative.