The Wealth Effect

March 22, 2013

This is one of those cool academic ideas that resonate with non-academics. If you’re an armchair economist you’ll nod and say, “oh yeah” when you read about it. I’m talking about the wealth effect. The wealth effect is the change in consumers’ attitude and spending behavior caused by the perception of increased wealth.

When a 10% tax hike to pay for the Vietnam War failed to slow consumer spending in 1968, economists attributed the behavior to the wealth effect. Disposable income actually fell, but paper wealth was rising sharply with the stock market, and consumers continued to spend.

We’re living through a good example right now. Most economists expected the January 1, 2013 2% tax hike from elimination of the temporary Social Security tax cut to reduce consumer spending because of reduced disposable income. It hasn’t, and the most likely cause is the current rebound in the housing market and the rise of stock prices; this may be leading consumers to feel more secure with their personal finances and ultimately spend more.

It’s important to note that the concept is that perception of increasing wealth trumps the reality of declining income. Don’t confuse the wealth effect with Alan Greenspan’s “irrational exuberance” which was fueled by a real increase in disposable income based largely on the housing bubble.

Of course, a rising stock market that goes on long enough should eventually lead to increased business confidence, hiring, falling unemployment, and a rise in disposable income. That would be great, because then we won’t be depending on perception, but on real prosperity.

 

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Economic Update: The View From 3 Months In

April 24, 2012

Except for those who are still unemployed, 2012 has been a good year so far. The U.S. economy is recovering slowly, and there are many indications it will continue to recover. Markets are up, with the Dow reaching the 13,000 milestone last seen in 2007. Greece hasn’t defaulted. Even unemployment is showing signs of improvement.

The U.S. picture
The consensus prediction is for 2% to 3% economic growth in 2012. That’s better than the 1.7% of 2011, but too slow to quickly cut unemployment from 8.3% to a more acceptable level.

Job creation, nevertheless, is increasing. December, January and February added 244,000 jobs a month, the most since before the Great Recession. Many experts think that productivity growth is maxed out and more hiring is inevitable. Businesses are investing in new equipment after spending the last two years increasing production by working off spare capacity.

Consumers are spending and borrowing again, even for big-ticket items like cars. February auto sales were at the highest since 2008. Housing starts show signs of recovery, spurred by continuing record-low mortgage rates.

So what gives us pause? Oil. Should tensions with Iran turn to war, higher gas prices would dramatically cut consumer spending, and slow the U.S. economic recovery as a whole.

Europe and Asia
Europe appears to have avoided a severe financial crisis, and while its recession is expected to be mild, the United States is feeling the effects. Banks with exposure to European debt, and the global economy as a whole, may be affected if debt restructuring doesn’t go smoothly.

China’s growth is slowing, impacting the global economy and the recovery of almost every nation. Can the Chinese avoid a hard landing on one hand, and avoid inflationary over-stimulation on the other hand? We’ll see.

What we think
We’d summarize the first quarter and the outlook going forward with two words: wary confidence. There might be some slowdown and market volatility. Oil prices will affect the economy. Fixed income has been a haven for investors, but that may be changing. Interest rates are likely to rise, and the 30-year bull market in bonds will become more bearish. And, as always, a diversified portfolio is a prudent hedge against unpredictable events and a good long-term strategy for investors.

 

Wealth Enhancement Group

There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.

Our “One and a Half Cents” on the Fourth Quarter – Part One

January 4, 2011

The stock market posted strong gains during the third quarter after rebounding from the low of the year that occurred near the end of the second quarter. The S&P 500 posted an 11% gain for the quarter. The strong gains during the quarter were far from steady. Volatility was high as the S&P 500 moved up and down within a 10% trading range. Cyclical, Mid-Cap, and European stocks fared the best during the quarter:

The highly cyclical Materials, Industrial, and Consumer Discretionary sectors were among the best performers while the legislation-sensitive Financials and Health Care sectors lagged.

According to data from the U.S. Treasury, purchases of U.S. stocks by foreigners in the third quarter of 2010 were likely strong based on the latest data available for July. On average, demand in recent quarters has only been exceeded in the past by the surge in buying around the market peaks in 2000 and 2007.

However, those foreign investors saw almost none of the strong gains in the U.S. stock market translate into their holdings due to the decline in the value of the dollar. The performance of the dollar-denominated S&P 500, when adjusted for the value of the dollar against major trading partners, was relatively flat for the quarter. If foreign investors fear further declines in the dollar, they may restrict their buying of U.S. stocks.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance reference is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.


Mid-Term Market Moves – Part 1

October 12, 2010

So far, the stock market performance in 2010 has tracked the typical pattern for U.S. stocks in mid-term election years, albeit with a bit more than the usual volatility. The path is usually range-bound and volatile, but capped by a strong fourth quarter rally averaging about 8%.

The market’s reaction to mid-term elections has nearly always been positive, even when the balance of power has shifted in one or both houses of Congress—as we expect this year with the Republicans having a good chance of taking the House. In four of the five years that mid-term elections resulted in a change in power (2006, when Democrats took the House and Senate; 2002, when Republicans took the Senate; 1986, when Democrats took the Senate; and 1954, when Democrats took the House), fourth-quarter returns were positive, much like those in mid-term election years when no change in power took place.


Fourth Quarter is Key

September 28, 2010

The fourth quarter may hold the key to the year for stock market performance. The restoration of a balance between the parties in Washington may be welcomed by markets. The market’s reaction to mid-term elections has nearly always been positive, even when the balance of power has shifted in one or both houses of Congress — as we expect this year with the Republicans having a good chance of taking the House on November 2. The average gain for the S&P 500 in the fourth quarter of a mid-term election year is a solid 8% (see the Weekly Market Commentary from August 2 entitled “Mid-Term Market Moves” for more information). This mid-quarter policy driver may be potent enough to turn sentiment around and produce gains for the year in line with our forecast for modest single-digit gains.


The Whole Picture

October 20, 2009

Do you have the diversification you need to keep your portfolio on track even when the stock market falters? The first step is to sit down with your financial advisor to take a closer look at your holdings to make sure your portfolio is well enough diversified to stand the test of time.

Does your investment portfolio have the diversification you need to sail smoothly through the ups and downs of the market? True diversification means more than spreading your assets around to a handful of stocks. It means putting assets into a variety of different types of investments beyond the stock market.

The younger you are the more aggressive you can be. While no strategy assures success or protects against loss, a portfolio heavily weighted in stocks might make sense for investors in their 20s and 30s. But the closer you are to retirement, the more important it is to spread some of your money to other types of investments.

Make sure you have the diversification you need to keep your portfolio on track even when the stock market falters, The first step is to sit down with your financial advisor to take a closer look at your holdings to make sure your portfolio is well enough diversified to stand the test of time.