Falling Stocks Are Threatening A Pillar Of The ‘Real Economy’

President Donald Trump and his advisors have dismissed falling stock prices, saying they’re more focused on the “real economy”—but falling stocks could undermine one of the main forces supporting job growth, economists say.

After financial markets plunged last week, sending the S&P 500 stock index into correction territory, Trump and his top economic advisors dismissed concerns about the economy’s future. After all, as the saying goes, the stock market is not the economy, even if it reflects business leaders’ expectations about where the economy is headed.

“Doesn’t concern me,” Trump said last week when a reporter asked him about the plunging stock market. “I think some people are going to make great deals by buying stocks and bonds and all the things they’re buying. I think we’re going to have an economy that’s a real economy, not a fake economy.”

However, there’s at least one way the stock market can impact the real economy, to the extent that the “real economy” consists of people’s ability to go to work, get paid, and buy goods and services.

Consumer spending is the main engine of U.S. economic growth as measured by the Gross Domestic Product, and falling stocks could throw some sand in that engine’s gears. That’s because over the past few years, as inflation has eroded the buying power of U.S. households, wealthier consumers have been increasing their share of the shopping, propped up by a formerly booming stock market.

The top 10% of earners were responsible for almost half of all consumer spending, the highest share recorded in data going back to 1989, according to an analysis by Moody’s Analytics for The Wall Street Journal.

The Wealth Effect

People tend to spend more when they feel wealthier, in an economic phenomenon known as the “wealth effect.”

Because higher-income households tend to hold more stocks, the big spenders could start to tighten their belts as a result of the recent sell-off. That could set off a domino effect leading to a recession: less spending means less need for businesses to hire, fewer people get paychecks, and the “real economy” takes a nosedive.

The steep rise in stock prices over the past four years has made the “wealth effect” more powerful than it usually is. One model by Oxford Economics showed that the wealth effect currently has four times its normal impact on consumer spending. That leaves the economy especially vulnerable if the effect goes away.

Consumer spending has been faltering in recent months, with retail sales plunging in January and recovering only modestly the following month.

“If the drop in equities persists, then it would negatively affect consumer spending,” Ryan Sweet, chief economist at Oxford Economics, wrote in a commentary last week. “Household net wealth matters more for the consumer spending outlook than before. A stronger wealth effect has proven to be a tailwind for overall consumer spending, but it could just as easily turn into an outsize drag in the event of a bear market.”