When Did We Stop Worrying About the Wealth Effect?

After a brief glimmer of hope, central bankers returned to their inflation at all costs mantra last week. Central bankers, across the board, including the Fed, sounded determined to plow ahead with their tightening plans, regardless of the impact on the economy. Markets shifted from trading on a bad news is good news basis (where bad economic/corporate news sent yields lower, which in turn helped stocks pop higher) to bad news being bad, with yields dropping (the 10-Year Treasury yield dropped from 3.48% on June 14 to 2.88% as of last Friday -- a drop of 60 basis points in two weeks! Of which, 25 of those bps occurred last week). Stocks fell last week, despite those lower yields, with the Nasdaq 100 leading the way with a 4% decline. This looks like a market pricing in a recession/policy mistake. Triggered by the Wealth Effect What really triggered me over the weekend, is that, if my recollection serves me right, every Fed Chair, including Greenspan, Bernanke, Yellen and even Powell (I think), has talked about the importance of the wealth effect. If I remember correctly, many, ahead of the Great Financial Crisis, argued that housing prices, on a yearly, national average basis, never went down. We know what happened when that occurred. While I'm not arguing that we are on the precipice of another GFC (banks are in incredible shape relative to then, etc.), I do think that this summer could see far worse economic data, far faster than any traditional model indicates, and the wealth effect will play a big part in that. Housing has surged more than it did ahead of the GFC and mortgage rates, from 7/1 ARMS to 30-year fixed have spiked between 2% and 3% higher in just six months! Not only have stocks done poorly this year, and last quarter, but so did bonds. There was little to no respite as even 60/40 strategies and other risk parity style strategies (any portfolio management relying on bonds to offset stocks) struggled. More recently, commodities have rolled over, clobbering many commodity stocks. Finally, the losses in crypto are real. Bitcoin and Ethereum, combined, have seen their market cap drop by $1.3 trillion since last November. The alt-coins and NFTs have done even worse on a percentage basis. The loss in crypto is real, this time around. While IPOs, SPACs and disruptive stocks have also been hit, I want to single them out, because the number of employees, through stock options, etc., who have seen incredible wealth evaporate quickly deserves special attention. I think the wealth effect will have two major impacts on the economy. Those who were truly rich from any of the above asset classes, will be forced to reduce their spending. They will need to focus on portfolio management and wealth preservation. I think the disruptive stock/crypto wealth effect is greater than the traditional 401(k)/generational wealth effect because it was concentrated, big and came so fast and seemingly easily. meanwhile, corporations are battening down the hatches and will have to be cautious on spending. Whatever your opinion is on crypto, for example, that community were big buyers of semiconductors (primarily for mining crypto) and clearly became a dominant force in ad spending (the Matt Damon Fortune Favors the Bold commercials will be forever etched in my mind -- in not a good way). Those are just examples at the fringe but if disruptive companies have to focus on earnings, slowing cash flow burn (for those that are cash flow negative) then spending cutbacks and job losses could ripple through the economy quickly. Don't fight the Fed, which unfortunately, for the moment, means remain cautious on risky assets!

When Did We Stop Worrying About the Wealth Effect?

This looks like a market pricing in a recession/policy mistake.

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