It is said that the economy is not the stock market. That is true; however, the stock market is critical to supporting household spending.
In our contemporary K-shaped economy, where higher-income consumers have thrived while those with lower incomes have struggled, paying close attention to the link between equity market valuations and household spending is one important way to monitor risk to the economic outlook in 2025.
A 2021 paper in the American Economic Review implies that for each dollar of increased stock market wealth, consumer spending rises by 32 cents. Given that overall household wealth in the U.S. has increased to $170 trillion—of which equity values contributed approximately $2.8 trillion through the end of the third quarter of 2024—risks around the magnitude and direction of economic growth have substantial exposure to the stock market. The S&P 500 rose 3% in the final three months of 2024 as this relationship gathered steam.
Given that a K-shaped economy rests upon large income inequality that skews spending toward upper-income households, frothy financial markets present risk to the overall economic outlook: A sizeable market correction would cause overall growth to slow.
Why is that?
If one looks at total average expenditures by income quintiles before taxes, the aspirationally wealthy and wealthy households represent 40% of total U.S. households, but they account for a disproportionate 66.64% of overall spending.
As equity valuations increase, these households tend to feel wealthier and subsequently increase their outlays on goods, services and housing. Those in the upper quintile may even use equity valuations and leverage to take greater risks in other financial markets or to support their own unique investment strategies.
Pretax income levels in upper-income households started at $116,717 for the aspirationally wealthy and $264,518 for the wealthy through the 2023 tax year.
By comparison, the working poor, working class and middle class households account for just 33.6% of overall spending. Should there be a large and persistent stock market correction, the 60% of households that comprise this income cohort simply do not have the wherewithal to support overall spending anywhere near current levels.
The takeaway? If there is a notable contraction in equity valuations, it is likely that the two upper-income quintiles of households would pull back spending in such a fashion that it could put at risk the above-trend growth the country is benefiting from in the current business cycle.
