Are Consumers Seeing Something Wall Street Isn't? What Spending May be Saying About Stock Market Valuation
The stock market continues to dance near all-time highs producing record highs in household balance sheets. Yet growth in consumer spending remains surprisingly moderate. While most forecasters look to changes in wealth as a driver of consumer spending, other researchers have concluded that the causality may go the other way. They find that when asset valuations and consumer spending become misaligned with their longer run relationship, asset valuations tend to correct back to trend. Subdued consumption may suggest downside risks to current equity valuations of as much as 30 percent, and other valuation metrics are also looking increasingly stretched. Recently these same researchers have concluded that asset price dynamics experience medium term regimes that are surprisingly inversely related to economic fundamentals. Low trend growth may lead to high asset prices in part because the Fed must employ persistently low interest rates to offset weaker trend growth, which in turn suppresses volatility and risk premia. That doesn’t mean asset prices go up forever in such a regime. In recent decades a higher average level of household net worth has also been associated with large, cyclical swings in asset prices and consumers may be telling us we are close to a peak.