Long Term Perspective

There is no question that wealth plays a role in determining consumer spending. During the great bull market of the 1990s, economists regularly commented on the “wealth effect” which caused consumers to outspend their income. This chart depicts annual growth in market wealth defined by funds held in corporate equities and at mutual funds. There are certainly other types of wealth, but this is a close proxy for stock market wealth. Notice that the sum of these funds (coming from the flow of funds report) moves in tandem with the Wilshire 5000, a stock market index that covers the entire U.S. market.

Short Term Perspective

Until summer of this year, stock prices during the first part of 2007 have followed the strength of economic data and have gone in the opposite direction of oil prices. During the summer and autumn, concerns of subprime lending practices and the value of related debt instruments by various financial institutions pulled equities down. Fears of the impact of the worsening housing decline on the consumer sector also weighed on equities in mid-summer. But stocks rebounded over the August through October period late due to the Fed’s cut in the discount rate in August and then again in September on the Fed’s cut in both the fed funds target rate and discount rate. Subprime concerns and fears of recession outweighed the impact of the Fed’s October 31 rate cuts, and pulled stocks down sharply in November.