Ten trillion dollars.
That rather unfathomable sum is the market capitalization the broad equity index of U.S. companies has added since stocks hit their bear-market low four years ago. The only thing more impressive is the $11 trillion previously lost by publicly traded U.S. firms over 17 months, from October 2007 through March 2009. That stretch also saw an unprecedented plunge in home prices.
Now both asset classes are resurgent. Homebuilders are backlogged and the Dow Jones industrial average is not far from a record high. And you can enjoy these things while the Federal Reserve is avowedly easy and McDonald’s (MCD) expands its dollar menu.
So to what extent do housing and stocks increase the wealth of America—and, more important, make Americans feel like they’re wealthier? As New York University economist Edward Wolff noted in his recent paper “The Asset Price Meltdown and the Wealth of the Middle Class,” median wealth plummeted over the years 2007 to 2010, hitting its lowest level since 1969. Moreover, the portion of wealth held by the wealthiest members of society rose sharply after moving little for nearly two decades.
Housing, notes Mesirow Financial chief economist Diane Swonk, “is the single largest wealth effect in the economy, and provides some reassurance that underwater mortgage servicers will be able to pull their heads above water. It also has multipliers in that those who refinance are more likely to take that saving and redeploy for a car payment or remodeling than when home values are falling.”
On top of boosting consumer purchasing power, increased home prices (and decreasing foreclosures) stand to embolden banks to be less stingy in their lending, and to make municipalities more confident in their tax collection. More gainfully employed construction workers upgrade from Taco Bell (YUM) to Five Guys. More appliance sales buttress Sears (SHLD) and Best Buy (BBY). It’s all good.
Data compiled by Bloomberg show that housing has helped lift the economy out of every recession since 1950 with the exception of this latest, lingering explosion. Mark Zandi of Moody’s Analytics (MCO) calculates that the above-mentioned fringe benefits of a rebound in residential construction will boost the economy by about 0.75 percentage points this year. In a recently updated paper (PDF), Karl Case, Robert Shiller, and the late John Quigley concluded that “changes in housing values continue to exert a larger and more important impact upon household consumption than do changes in stock market values.” They now posit that the virtuous cycle spawned by rising home prices—from actual and anticipated gains—will juice U.S. consumption by $80 billion this year.
Citigroup (C) disagrees; its research says the stock market packs the disproportionate wealth-effect punch, especially where retail sales are concerned. Home equity only accounts for 10.5 percent of American household-sector wealth and never got much above 22 percent at the height of the housing bubble, the bank notes. As for stock holdings, 90 percent of shares are held by the top 20 percent of income earners, who in turn chip in almost half of all discretionary spending.
Which leaves the question: How will the market’s ascent impact the behavior of the thinned ranks of middle-income investors? Much of the brokerage-account gains are on paper, in contrast to the more immediate added spending power of home refinancing and reduced mortgage distress. It’s unclear to what extent individual investors altogether dropped out of the market, which got hit not only by the Panic of 2008 but also the Flash Crash of 2010 and the Euro and U.S. debt sell-off of 2011.
Pimco Chief Executive Officer Mohamed El-Erian writes that the Dow has recovered to 14,000 via six years of “taking investors on a massive roller coaster—emotional and financial. … As wonderful as stock market rallies are, they don’t mean much if they are not ultimately validated by a vibrant economy, lower unemployment and financial stability.” (A bit of nostalgia: “This thing has an obvious psychological effect,” declared a broker in response to the Dow breaking 1,000 in 1972. “It’s a hell of a news item. As for the permanence of it—well, I just don’t know.”)
Forty-plus years later, and just four years removed from an outright meltdown, the market is now apace to do a melt-up, according to spectators such as Ed Yardeni. But that is dangerous territory: It hasn’t had a correction since late 2011. Which makes some observers chary of any wealth-effect gains.
“I just don’t buy the trickle-down argument that higher stock markets lead to a stronger economy,” says Tim Price, director of investment at PFP Wealth Management in London, and author of a Feb. 4 note titled “This Is Going to End Badly.” “The reason I’m so disturbed by the current market is the extent to which price signals have just been crushed by trillions of thin-air money. The prices of just about every financial asset are hopelessly distorted. The reckoning is going to be terrific.”
And with investors so hesitatingly coming back, that reckoning—which is routine, historically—could well get them wealth-disaffected all over again. They’re probably mindful that the market has merely climbed back to where it was in 2000, which is also the last time many of them were stoked about stocks.
