To put it mildly, observers of U.S. financial markets and the U.S. economy over the past year have been experiencing cognitive dissonance. On the one hand, the stock market has posted its largest increase in recent memory, leaping by some 35% last year and still counting. On the other, the economy crept higher at a lackluster 1.4% pace, consumption has lagged, and economic anxiety is widespread.
To those who equate stock market booms with economic welfare, all of this is puzzling. With all of their added wealth, why aren't consumers spending with elan? And why is there so much malaise in the hinterland?
A new study by economists James M. Poterba of Massachusetts Institute of Technology and Andrew A. Samwick of Dartmouth College throws some light on such issues. The study's focus is the so-called wealth effect, the theory that a rise in stock prices makes people with stock investments feel richer and thus leads them to spend some of their added wealth--boosting consumption and spurring economic growth.
A key question, of course, is the nature of stock ownership. Using Federal Reserve data, the researchers calculate that the household sector--both directly and indirectly, via mutual funds and defined-contribution pension and savings plans--currently owns nearly two-thirds of total U.S. equities. Moreover, the share of households with stock holdings grew from 19% in 1962 to 33% in 1992--and has undoubtedly risen since then.
A problem, however, is that a large number of such holdings are either negligible or relatively inaccessible for spending. In 1992, for example, only 17% of households had more than $2,000 in stocks or mutual funds outside of tax-favored savings and pension plans with penalties for early withdrawals.
Moreover, stock ownership is highly concentrated. Based on the Fed's 1992 survey of consumer finances, Poterba and Samwick estimate 5% of households own 77% of all shares held by individuals and families. And 80% of households own 2%. Subtracting holdings in tax-favored pension and savings plans, the equity share of the bottom 80% of households drops to a scant 0.5%.
Thus, any impact on consumption from rising stock prices is likely to be found among the wealthiest families--say, the top 10% who account for 90% of household equity holdings. Yet in analyzing past stock market and consumption patterns, the researchers find no significant relationship between rising (or falling) stock prices and subsequent sales of luxury cars and other items purchased by affluent families.
The findings suggest that anyone looking for a direct wealth effect from last year's stock boom is likely to be disappointed. Still, the authors note that market rises are usually followed by consumption increases--presumably because stocks, by reflecting earnings expectations, remain a good leading indicator of overall economic activity. So the boom still points to a likely consumption rebound in the months ahead.
Perhaps the most intriguing aspect of the study is what it implies about wealth dispersion. Because substantial stock ownership is confined to relatively few households whereas most families' net worth is centered in home ownership, the latest stock market boom suggests that the wealth gap in the U.S. has inevitably widened.