CNN/Money  
graphic
News > Economy
graphic
Return of the wealth effect?
The stock market's recent rally should give the economy a boost, right? Not so fast.
June 6, 2003: 5:10 PM EDT
By Mark Gongloff, CNN/Money Staff Writer

NEW YORK (CNN/Money) - After a three-year bear market, when the term "wealth effect" became a cruel joke, stocks are suddenly soaring.

Could the rebound in the market mean the return of the "wealth effect," when people feel richer because their portfolios are fatter, and so go out and boost spending, thereby boosting the economy? Hold the phone.

“ The consumer didn't die. People lost all kinds of money in the stock market, and it didn't seem to affect them. ”
Robert Brusca
Native American Securities

Since bottoming out on March 11, the Dow Jones industrial average is up more than 20 percent, the S&P 500 index is up about 25 percent, and the Nasdaq is up about 30 percent.

That has led some economists to speculate that consumers, whose spending fuels two-thirds of the economy, will see their retirements account improving and will feel even better about putting more of their paychecks back into the economy.

"I would interpret higher stock prices in two ways," said former Federal Reserve Governor Lyle Gramley, now a consulting economist with Schwab Washington Research. "It's an indication of improving confidence in the economy's recovery, and it increases the confidence and wealth of consumers, adding to consumer spending."

What's more, in a rising market, businesses can raise more money by issuing stock than they can in a falling market, giving them more cash to invest in improvements and hire workers.

"You're effectively lowering the cost of capital for corporations, and anything to lower that cost will help in inducing more plant and equipment spending," said Northern Trust senior economist Paul Kasriel.

Waiting for good dough

Of course, businesses haven't started doing that just yet.

And business investment and hiring is crucial for the economy to regain strength, most economists believe. Since the 2001 recession started, employers have cut about 2.5 million jobs. Companies, shell-shocked by the recession, terror attacks, corporate scandals, war and other woes, have been reluctant to spend and hire until they see enough demand to justify it.

These factors have conspired to knock the economy around in 2002 and 2003 -- gross domestic product (GDP) posted only two strong quarters of growth in 2002 and has been weak in the first half of 2003. The stock market, too, has rallied from time to time, but those rallies haven't been sustained.

graphic
graphic graphic graphic
graphic
CNNfn's Valerie Morris reports on the job market and what you should know if a pink slip is headed your way.

Play video
(Real or Windows Media)
graphic
graphic

Given the recent history of ups and downs, some consumers and businesses might be inclined to stay on the sidelines for longer than usual, meaning the economic impact of the recent stock market gains might be diluted.

"It will have some positive effect, but I don't think there's a strong conviction the stock market rally is going to be sustained," said Wells Fargo chief economist Sung Won Sohn. "No one is really cashing it in and beginning to spend more money."

Sohn believes that, in order for the rally to hold long enough to start generating a "wealth effect," it will have to be accompanied by sustained improvement in corporate profits and stronger GDP growth for at least two or three quarters, a scenario that's not yet in the bag.

"Clearly, the economic fundamentals of monetary and fiscal policies, as well as the falling value of the dollar, support a recovery," Sohn said. "What we're not sure of is how strong the recovery is going to be."

And some economists wonder if there really is much of a correlation between stock prices and how consumers behave. After all, consumers have kept plugging along, barely cutting their spending, despite the queasy ups and downs of the bear market.

"Where was wealth effect during that time?" asked Robert Brusca, chief economist of Native American Securities. "The consumer didn't die. People lost all kinds of money in the stock market, and it didn't seem to affect them."  Top of page




  More on NEWS
JPMorgan dramatically slashes Tesla's stock price forecast
Greece is finally done with its epic bailout binge
Europe is preparing another crackdown on Big Tech
  TODAY'S TOP STORIES
7 things to know before the bell
SoftBank and Toyota want driverless cars to change the world
Aston Martin falls 5% in its London IPO




graphic graphic

Most stock quote data provided by BATS. Market indices are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer. Morningstar: © 2018 Morningstar, Inc. All Rights Reserved. Factset: FactSet Research Systems Inc. 2018. All rights reserved. Chicago Mercantile Association: Certain market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. Dow Jones: The Dow Jones branded indices are proprietary to and are calculated, distributed and marketed by DJI Opco, a subsidiary of S&P Dow Jones Indices LLC and have been licensed for use to S&P Opco, LLC and CNN. Standard & Poor's and S&P are registered trademarks of Standard & Poor's Financial Services LLC and Dow Jones is a registered trademark of Dow Jones Trademark Holdings LLC. All content of the Dow Jones branded indices © S&P Dow Jones Indices LLC 2018 and/or its affiliates.

Most stock quote data provided by BATS. Market indices are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer. Morningstar: © 2018 Morningstar, Inc. All Rights Reserved. Factset: FactSet Research Systems Inc. 2018. All rights reserved. Chicago Mercantile Association: Certain market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. Dow Jones: The Dow Jones branded indices are proprietary to and are calculated, distributed and marketed by DJI Opco, a subsidiary of S&P Dow Jones Indices LLC and have been licensed for use to S&P Opco, LLC and CNN. Standard & Poor's and S&P are registered trademarks of Standard & Poor's Financial Services LLC and Dow Jones is a registered trademark of Dow Jones Trademark Holdings LLC. All content of the Dow Jones branded indices © S&P Dow Jones Indices LLC 2018 and/or its affiliates.