Dissipating Wealth Effect to Drive GDP Lower

As America — and the rest of the world for that matter — teeters on the brink of recession, it’s important for investors to factor in a dissipating wealth effect on consumer confidence and consumer spending as we dig our heels into what 2023 is going to look like. 

After all, it is the consumer that’s the main driver of GDP. 

Dissipating Wealth Effect to Drive GDP Lower

The bottom line reality is that people are “feeling” a lot less wealthy than they were just a year or so ago due to:

  • Falling home values
  • Declining 401(k) balances
  • Higher borrowing costs 
  • The end of the bull run in stocks 

The psychology behind the wealth effect is “perceived wealth” — meaning that people typically spend more when they’re feeling wealthier (regardless of their actual bank  account balances) and spend less when things aren’t looking quite so rosy. 

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Collectively, as consumers and investors, we’re coming off of a decade-plus of the Fed’s easy-money policies, coupled with a long bull run in stocks, plus an equally impressive rise in home values. 

Looking back… what wasn’t there to love!

As COVID hit our shores starting in early-2020, the Fed resorted to an even easier monetary stance… adding further impetus to the bull run in stocks and, in turn, to a wildly strong surge in home values.

Household wealth in the US surged from $116 trillion at the end of 2019 to $149 trillion at the end of 2021 — or around 150% of GDP annually during that span. 

Fast-forward to today and the picture is quite the opposite.

The Fed, as you’re well aware, is in the midst of an historic tightening cycle… including this week’s rate hike of 25 basis points. 

In other words, Powell & Co. have gone from flooding the economy with liquidity to literally draining it!

The end result, thus far, has been a precipitous market drop of about 20% along with a doubling in mortgage rates from around 3% at the start of last year to roughly 6% now — not to mention the demise of other riskier asset classes like cryptocurrencies.

Home prices are now declining in most markets with many experts expecting the pain to continue throughout the current calendar year.

So not only are most people “actually” less wealthy than they were before the start of the pandemic… but they’re “feeling” a lot less wealthy on top of it.

Corporations are feeling the pinch of higher borrowing costs as well, particularly in the tech sector where a massive wave of layoffs has taken hold, including stalwarts like Amazon, Google, Microsoft, and Meta — to name just a few. 

From Wall Street to Main Street, a dissipating wealth effect is being felt, and it’s going to have a detrimental effect on GDP over the coming few quarters as corporate America tightens its belt and as consumers pull back on their discretionary spending. 

Already, what we’ve seen in recent quarters has been a bit of a roller coaster ride: Q1 and Q2 of last year saw negative GDP growth followed by a positive GDP number in Q3.

Q4 was in the black as well. Yet, that trend will likely give way to another round of negative numbers in Q1 and Q2 of this year for the reasons just described. 

GDP: Percenr change from preceding quarter

Naturally, the Fed is looking to get inflation under control via its aggressive rate-hike stance without sending the US economy into a death spiral.  

The Fed’s goal is what economists and government pundits alike refer to as a “soft landing” where inflation returns to normal levels without a mass exodus in the labor market triggering an elongated recession.  

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At this juncture, there’s really no telling how soft or how hard the landing will ultimately be as there are a number of unpredictable factors in play — including the war in Ukraine and its effect on geopolitical stability and energy security. 

We also have China’s recent and somewhat unexpected shift away from its draconian zero-COVID policy following a wave of unprecedented protests among its citizenry. 

China’s economy stagnated under zero-COVID-rule… and the nation’s recovery will depend largely on President Xi’s ability to stimulate domestic consumption on the resilience of Chinese households that — just like US households — are feeling the pain of a dissipating wealth effect.     

With the trickle down effect from China and Europe, coupled with the negative economic factors we’re facing here at home, another leg down in US markets is a very real possibility for the first half of 2023. 

And that means investors need the proper guidance to navigate through what looks to be turbulent times ahead before a sustainable economic recovery can take place. 

To that end, our own Nick Hodge of Foundational Profits has successfully beaten the market seven out of the last eight years… no matter which direction the indices were moving at any given point. 

And that includes last year where his model portfolio was up more than 30% for the year — including no less than four triple-digit winners. 

Nick is primed and ready to deliver those same types of spectacular gains this year… whether we end up with a soft or hard landing. 

Don’t miss Nick’s first recommendations of 2023… they’re just a click away!

Mike Fagan

Mike Fagan
Editor, Daily Profit Cycle