Stock plunge would need to get much worse to derail economy

WASHINGTON – Monday’s stock-market plunge is unlikely by itself to make a significant dent in a U.S. economy that’s enjoying solid gains in spending and hiring, though it has the potential to rattle consumer sentiment, which soared after the November 2016 election.

The impact on growth, according to economists, will depend on whether the market keeps falling, or otherwise fails to rebound and build on last year’s strong performance, which saw the Standard & Poor’s 500 index rise 19 percent. The benchmark gauge tumbled 4.1 percent on Monday at the close in New York, the most since August 2011.

“This is the stock market. This is not the economy,” said Allen Sinai, president of Decision Economics Inc. in New York. “Underneath, the U.S. and world economies look very good. The stock market outran the state of the U.S. and world economies, and overpriced itself for this early in 2018.”

The declines on Monday erased 2018’s gains. Gauges of consumer confidence, such as the University of Michigan’s monthly survey and the weekly Bloomberg Consumer Comfort Index, tend to parallel the U.S. stock market over time. The Bloomberg gauge reached the highest level since early 2001 in its latest reading last week, while the Michigan index is close to a 13-year high.

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“The rise in wealth has contributed to strong consumer confidence and it’s one of the factors that’s led to strong spending,” said Lewis Alexander, chief U.S. economist at Nomura Securities International Inc. in New York and a former Fed official. If the slide in stocks persists, “it can only have a negative impact.”

Guy LeBas, chief fixed-income strategist at Janney Montgomery Scott LLC in Philadelphia, said that “if we have a sustained equity market sell-off that gets north of 10 percent and goes on for a couple weeks, then I’d say you’d see a little bit of a dent in consumer sentiment. But I don’t think it’s there yet.”

The broader economy has shown few signs of distress. Gross domestic product grew at a 2.6 percent annual pace in the fourth quarter and consumer spending rose at the fastest rate in more than a year. Labor Department figures showed last week that employers added more workers than projected in January and average hourly earnings rose by the most since 2009. Manufacturers and service providers are reporting some of the strongest gains of the expansion, according to Institute for Supply Management indexes for January.

What Bloomberg economists say

“There is a high correlation between consumer confidence and the equity market. If this is a one-off sell-off, it wouldn’t have an impact. The fact of the matter is financial conditions are tightening. If you do see a sharp deterioration in financial conditions, that could throw a wrench in” firms’ expansion plans, said Michael McDonough, chief economist, Bloomberg Economics. One caveat: the saving rate fell in December to a 12-year low as shoppers splurged during the holiday-shopping season, suggesting they might have less wherewithal to boost spending in coming months.

The “wealth effect” on consumer spending from rising asset prices may also be less pronounced when it comes to stocks, as compared with housing. A 2005 paper by economists Karl Case, John Quigley and Robert Shiller found that annual changes in consumption were correlated with changes in housing wealth but not stock-market wealth.

“Suppose we had a bear market – prices fall by 20 to 25 percent and stay down. That becomes a real threat to the expansion,” said Mark Zandi, chief economist at Moody’s Analytics Inc. in West Chester, Pa. “If that’s the scenario, it’s probably more than stock prices that are correcting.”

Katia Dmitrieva and Rich Miller are Bloomberg News staff writers.