Stock Market Swings Heighten U.S. Inequality Worries

Middle and lower-income consumers are pulling back in spending, according to recent earnings reports by consumer companies like Home Depot and Chipotle. (Spencer Platt/Getty Images)

Americans are getting both richer and poorer.

The gains in the stock market this year have only made inequality, and the problem for policymakers of what to do about it, more urgent. More recently, volatility in stocks and an uncertain outlook for the Federal Reserve have made the problem even more vexing.

Affluent Americans have seen their wealth driven up by successive years of double-digit growth in the stock market and real estate values. Meanwhile, lower-end earners are feeling pain. American workers whose wages aren’t keeping up with inflation may be the ones impacted by the softening job market. And that group benefits least from stock market gains.

“This is an economy that adds up on paper to look better than it feels to most Americans,” said Diane Swonk, chief economist at KPMG. Wealthier households are disproportionately driving consumer spending. The top 10% earners are responsible for about 50% of consumption**,** according to Moody’s Analytics.

The fact that a small group of consumers is driving growth leaves the economy more susceptible to a downturn. Higher-end households are more vulnerable to a stock market correction, for example.

Hints of that vulnerability began to materialize this month. Hundreds of billions of dollars were wiped from public markets after prominent CEOs and analysts started publicly vocalizing concerns about an AI bubble. The has fallen in five of the past six trading days, and is down 5.1% from its record on Oct. 28, according to Dow Jones Market Data.

Despite the narrow base for consumer spending, even a fall of that scale likely isn’t sufficient to knock the economy off course.

“It is going to be in hindsight that we know if this sell-off is going to hurt the consumer,” said Peter Boockvar, chief investment officer at One Point BFG. He said if the S&P 500 dips to 5,000, the high-end consumer will be hurt. If the correction remains below 10%, however, “it will have no effect.”

Boockvar said it will be important for the AI trade to see how Nvidia continues to trade in the next couple of sessions after its earnings report Wednesday afternoon. The stock initially moved higher on better-than-expected revenue.

“It’s not a debate about whether the quarter was good or not,” Boockvar said. “The debate is what has the stock already priced in. Nvidia is certainly at the center of this AI party.”

He noted Wall Street pushed back on Oracle and Meta after their earnings for spending too much, and Nvidia is impacted by hyperscalers’ spending.

“There are some cracks,” he added. “We’ll see.”

This all leaves the Federal Reserve in a bind. The Fed voted to cut rates by a quarter point in October. But there were two dissents, reflecting a divide in opinion over the state and trajectory of the economy.

Michael Gapen, chief U.S. economist at Morgan Stanley, said the Fed’s divide can be seen through the lens of the consumer. There isn’t a perfect interest rate policy stance that works for both the top and bottom consumer groups.

The Fed is “cutting rates to provide insurance for the labor market,” Gapen said. “The cost of that insurance comes in the form of potential tolerance for inflation and stoking potential asset price bubbles.”

Top earners and consumers aren’t held back by interest rates at their current level, Gapen added.

“Then you look on the other side, and the labor market has weakened a lot. Real income growth for lower middle-income consumers has slowed and is close to zero on average. Auto loan rates are high. Mortgage rates are high,” he said.

In October, the share of subprime borrowers who were at least 60 days late on vehicle loan payments rose to 6.65%, the highest level on record.

The wealth gap has increased dramatically since the Covid-19 pandemic.

“We’ve seen an increase in household net worth of $57 trillion over the last five years,” Gapen said. The top 10% of income earning households now hold about 85% of the financial wealth in the economy, he said.

A stock market downturn could erase some of that divide. But it could also lead the U.S. into a recession.

“We could see a blow dealt to the last bastion of consumers willing to spend with abandon: the affluent,” said Swonk. “That would slow consumer spending significantly. We are as close as I have ever seen to a payroll recession with the economy still growing.”

The Fed’s next rate decision is Dec. 10. The futures market is becoming increasingly less confident that there will be another rate cut. The odds of a cut sank from 66% earlier this month to less than 33% on Wednesday.

But the Fed must worry that if it keeps rates steady, the U.S. could fall into a recession, said Claudia Sahm, chief economist at New Century Advisors.

“If they don’t cut, they might push the labor market over the edge and have a recession,” Sahm said. But the Fed also risks stoking inflation, hurting bottom wage earners, if they do cut.

“It is these risk scenarios that are animating them,” Sahm said. “When their dual mandate is in conflict, fundamentally it is going to be a difficult assessment.”

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