The AI stock price bubble and consumer spending Ponzi loop?
– by New Deal democrat
One of this things that has puzzled me for the last few months is why consumer spending has remained so strong in the face of so many headwinds in the economy, some from horrible policy coming out of Washington, some embedded in the long leading and short leading sectors.
There is no economic news today, so let me deviate from my normal routine to explain my best hypotheses: namely, that the stock market and consumer spending are presently in a self-reinforcing positive feedback loop. By this I mean that the wealth effect from increasing stock prices is causing the uppermost income brackets to spend more, which only reinforces the earnings of companies which cater to them, which gives rise to further stock appreciation and so on.
To start, here is a graph of real retail sales (orange), real personal spending (red), and the S&P 500 (blue, right scale) since mid year 2024:
It’s not difficult to see that the patterns are similar. The tariff front-running coincided with new highs in the market, followed by the post- “Liberation Day” swoon, followed by renewed optimism and purchases. This despite the fact that the housing market, some measures of manufacturing, and transportation are recessionary, new vehicle sales are roughly flat, and production has either turned flat or at best slightly increased.
Let me next re-up some graphs that have been posted in the last few days by CNBC’s Carl Quintanilla.
First, after tax wages and salaries have increased much more than those for lower income households:
Unsurprisingly, lower income households have become stretched. While they haven’t cut back on their spending, it hasn’t increased either:
But higher income households are doing just fine.
And driven by those upper income households, US stock allocation is at an all-time high, even surpassing 1999 and 2005:
Currently stock prices are up 16% YoY:
An upper income household that had $500,000 in stocks one year ago now has $80,000 more in paper wealth; if a wealthier household had $1,000,000 in stocks, it now has $160,000 more wealth on paper, and so on.
And some of it is being spent. That’s the wealth effect.
Now, the obvious problem with all this is, what happens if and when the stock market reverses. And there is every reason to believe it will reverse. That’s because almost all of the earnings gains in stocks have been confined to a very narrow group that dominate the social media/AI space. To wit, *ALL* of the recent earnings upgrades have come from just 7 of the 500 stocks in the S&P 500:
And the advance-decline line (the number you get when you subtract the number of stocks with daily declines from those with daily increases) has remained almost flat since the beginning of July (up about 0.5%) vs. the S&P 500, up about 3%:
This by no means tells us anything about *when* there might be a reversal. But the above graphs are warning signs that stocks are very vulnerable to such a reversal. It also doesn’t tell us what the source of the reversal might be. For example, in 2000 the reversal in the internet stocks bubble began when Barron’s magazine published a front page story about the “burn rate” for various of those stocks, showing that some of them (I think pets.com was the leading example) were within 7 weeks of running out of money.
But I think the above is the best explanation about why consumer spending is holding up so well. Because people react much more strongly to losing money than gaining it. It also strongly suggests that if there is a stock market reversal, in this overall economic environment consumer spending is going to decline in pretty dramatic fashion.
Has consumer spending really been flagging in 2025? Angry Bear by New Deal democrat
I look at the fiscal position of the US. First is the net financial position of the private domestic sector. To calculate this take total government debt and multiply by the percent held by private domestic sector. Divide this by the total government debt. Historically this needs to be above 40% for the economy to be sustainable. Next is the annual domestic savings rate. This is the annual government debt minus the trade deficit. Divide this by the U.S. annual GDP. This number needs to be above 2-3% to satisfy the savings desire of the private sector. Right now both look good for economic growth.
No method is 100% accurate because of geopolitical factors such as supply shocks, war, pandemics, etc.
I would suggest reading Nobel Laureate William Vickrey’s “we need a bigger deficit” for more on this.
This is good information that needs to be publicized to understand why so many claim the economy is doing so well while so much of the population is unhappy with the economy.
The icing on the cake for the top 10% is that many have mortgages bearing 3% interest rates. Debt service on most mortgages remains constant for the life of the mortgage. That means that the real value of the mortgage has been declining, as has the real debt service. In other words, the top10% has seen their incomes increase at the rate of inflation (or higher) while their biggest expense remains constant. This frees up disposable income, which, backed by the confidence generated by increasing paper wealth, stimulates higher spending.
Jaclyn Peisek, WaPo, 2/20/25: “Americans’ long-running spending boom is showing signs of faltering as consumers of all income levels scale back and hold out for discounts, leaving the economy on shaky ground. This shift is most pronounced among lower-income consumers, who are disproportionately vulnerable to rising prices and other economic pressures eroding their purchasing power, industry analysts say.” U.S. economy feels the pinch as low-income consumers cut spending – The Washington Post
When the Top 10%, who account for 50% of consumer spending, start to scale back, you know there is trouble on the horizon.