Commentary: Why Market Wealth Won't Stoke Consumer Spending

The stock market's stellar performance in 1995 is giving investors good reason to rejoice. But the euphoria on Wall Street doesn't mean a gold rush in the shopping malls--and that's a good thing for a savings-starved U.S. economy.

Historically, big changes in equity values haven't had much immediate impact on consumer spending patterns. The crash in October, 1987--which took a full 25% off the value of the stock market in only a couple of weeks--barely slowed the economy. Consumers pulled back slightly at the end of 1987, but quickly regained their confidence in the first quarter of 1988 and started spending again.

Over the past year, the value of individual holdings in the stock market has jumped by nearly a trillion dollars. But estimates by Laurence H. Meyer & Associates, a St. Louis-based economic forecasting firm, suggest that the short-run "wealth effect"--the response of consumer spending to rising equity values--is not very strong. The dramatic rise in the markets could translate into a $30 billion increase in consumer spending this year. That may seem like a lot, but compared with the $5 trillion annually that American consumers are spending already, it's only a 0.6% increase--hardly enough to guarantee retailers a merry Christmas.

MARKET-SENSITIVE. A reason for the weak response is that only about a quarter of American households own stocks and mutual funds, compared with 65% that own their own homes. That's why consumer spending is more sensitive to ups and downs in the real estate markets than to the gyrations of the stock market.

But this may change as more American workers put their money into 401(k) retirement accounts. It used to be that households owned big chunks of stock indirectly through pension funds, which meant that they never benefited from the gains resulting from a rising market. Instead, a stock market boom, like the one in the 1980s, simply meant that their employers had to contribute less money to maintain the defined benefits.

If Americans become accustomed to checking the value of their 401(k) plans as often as they calculate the balance on their checking account, their spending will become more sensitive to the state of the market. According to estimates by Access Research Inc. in Windsor, Conn., the value of 401(k) plans surged from $525 billion at yearend 1994 to a projected $640 billion at yearend 1995, with the bulk of the gains coming in equities. At the same time, defined benefit pension plans are becoming less important.

BIGGER STAKE. This shift in retirement funds is giving workers a bigger stake in the stock market's overall performance. Over the past year, with soaring corporate profits driving up the stock market, someone holding $20,000 in their 401(k) plan's stock index fund would have seen an increase of $6,000--probably as big as any salary raise they might have received.

But that doesn't mean that people should spend more because their retirement accounts are growing fatter. At a time when baby boomers are starting to feel the aches and pains of middle age, it's far more important that they build a nest egg for retirement than buy another toy or bauble for the holidays. And the U.S. economy will benefit more from a higher savings rate than it will from a short-term spurt in consumption.

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