Wall Street's swings could hurt growth

Market volatility could lead public to reduce spending

Confidence could erode

Time will tell whether braking will be hard or soft

April 09, 2000|By William Patalon III | William Patalon III,SUN STAFF

If the violent mood swings that stocks have seen this year should persist, they could cause enough angst to slow consumer spending and dent the longest period of prosperity the country has ever seen, market experts say.

"This kind of volatility can erode consumer confidence very quickly," said Anirban Basu, director of applied economics at the Regional Economic Studies Institute affiliated with Towson University.

"If the financial markets continue to behave so frantically, consumer confidence [could] go down over the next several months. That's not to say we're facing a recession. -- What's more likely to happen is that consumers will slow spending" -- which will put the brakes on U.S. growth.

Just how much growth will slow -- whether the brakes are tapped gently, or slammed to the floorboard -- will take time to see. The Federal Reserve has raised interest rates five times since the summer in hopes of slowing the thundering U.S. economy, apparently to little effect.

Through the final months of last year and into the first month of this year, consumers, buoyed by an obliging bull market, remained confident -- and willing to spend. And never have more Americans tied their fortunes to Wall Street -- half of U.S. households own stock in some form.

Today, however, stocks sit well off their highs, making people feel they have less wealth to spend. And the day-to-day swings in stock prices -- not to mention the gripping swings that occur between that morning bagel and afternoon cup of coffee -- make the future seem less bright. Consumer confidence remains high, but looks to be heading down.

In January, the Conference Board's closely watched Consumer Confidence Index peaked at an all-time high of 144.7.

But that index slumped to 140.8 in February, below the reading of 143 analysts had expected and the first decline since October.

It fell again in March, this time to 136.7, and the Conference Board concurrently said that consumer expectations for the next six months dropped to the lowest point since the fall.

In an economy this strong, with jobs so plentiful, why would confidence slump?

Initially, economists blamed rising oil prices and the increased interest rates. But now they say to look no further than the Dow Jones industrial average, which closed at an all-time record high Jan. 14, but immediately turned south in a sell-off that had market mavens talking about bear markets.

"The stock market and consumer confidence these days are well-tied together," said Eugene Fram, the J. Warren McClure marketing research professor at the Rochester Institute of Technology's College of Business.

That's how the Conference Board sees it, too: A key culprit in the dimming of consumer ebullience is the uncertainty created by stock-market volatility, it said.

Economists know that days like Tuesday -- when the Nasdaq dived nearly 575 points and the Dow industrials experienced a 600-point swing before recovering most of their losses -- give consumers the jitters.

But it's not clear just how jittery those consumers must become before they change their spending habits enough to slow the economy down, or even to upend it into a recession. That's because there's never been a period of prosperity like this one.

Historically, spending by individuals has accounted for two-thirds of the nation's economic activity, though during the current boom the percentage has at times been 70 percent and higher.

"The stock market does have some impact on consumer spending," said William Cheney, chief economist for John Hancock in Boston. "It sets the tenor of the nightly news. If the stock market is gyrating, Peter Jennings puts it on the air."

But just how much stocks must fluctuate -- and over what period -- before they temper spending isn't yet known.

"My sense of it is that it would take -- a duration of three to four months of -- not only volatility -- but of essentially no growth in any of the indexes," said David Orr, chief economist for First Union Corp., in Charlotte, N.C. "The duration of the decline -- and more importantly, the depth of the decline -- is what changes consumer psychology."

Partly at issue is the "wealth effect," which attempts to relate increases in a consumer's stock portfolio and and real-estate holdings to spending. There's a lot of debate on that point, but most analysts say that for each dollar increase in wealth, spending increases anywhere from a penny to 4 cents. There's also a lag: Studies show that even when consumers see their holdings rise, months or even a year must pass until these investors view this extra money as "theirs."

Another factor is believed to be a "reverse wealth effect" -- a drop in spending when falling stock or home prices leave consumers feeling less prosperous. The crimp in consumer spending isn't immediate here, either, as was proved by the big slides U.S. stocks saw in late 1998 courtesy of the Asian economic crisis; economic growth wasn't interrupted.

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