Stocks Lift Wealth, Challenge Fed’s Inflation Control

With 62% of U.S. adults owning a stake in corporate America, reducing consumer demand to lower inflation seems challenging.

U.S. stocks hit new all-time highs last week, boosting the financial well-being of millions and complicating the Federal Reserve’s inflation fight.

According to Gallup data released this month, 62% of U.S. adults have investments in the stock market through direct shares, mutual funds, 401(k)s, or individual retirement accounts, a level consistent with 2023 and similar to 1998-2008.

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Even low-income households, earning less than $40,000 annually, and middle-income households, earning up to $100,000, participate in the stock market: 25% and 65%, respectively, based on Gallup’s survey conducted from April 1-22.

The May rally in equities, with the Nasdaq Composite reaching 16,920.79 and the S&P 500 hitting 5,321.41, makes it hard to see consumer demand tapering enough to bring down inflation.

By Friday, the Nasdaq Composite, S&P 500, and Dow Jones Industrial Average had risen 8.1%, 5.3%, and 3.3% for May.

The coming week will provide fresh data on consumer attitudes and U.S. inflation. Tuesday’s Conference Board consumer-confidence reading for May and Friday’s personal consumption expenditures price index will be key.

A strong labor market and continued consumer spending are helping the U.S. avoid a recession, but record prices on Wall Street may be fueling a negative feedback loop on inflation. This disconnect between perceived wealth and economic sentiment is evident in a poll by Harris for the Guardian, which found many believe the economy is in a recession and that the S&P 500 is down for the year, though it isn’t.

The wealth effect, a tendency to spend more as wealth increases, even if income does not, may be at play. Analysts like Torsten Slok of Apollo Global Management link the Fed’s rate cuts in 2024 to consumer spending driving higher-than-expected inflation in the first quarter.

In December, Charlie McElligott of Nomura Securities International warned that the Fed’s dovish pivot in late 2023 might boost “animal spirits” and ease financial conditions, making it harder to control inflation.

First-quarter inflation readings were hotter than expected, and despite three months of little progress towards the 2% target, Fed Chairman Jerome Powell indicated on May 1 a low chance of future rate hikes, sparking the stock rally.

Brent Schutte of Northwestern Mutual Wealth Management noted that the wealth effect is keeping inflation elevated and that the stock market is complicating the last mile of inflation reduction.

The question now is whether the “risk-on” appetite, driven by tech-driven productivity hopes and solid corporate earnings, can coexist with inflation above 2%.

Minutes from the Fed’s April 30-May 1 meeting showed some officials’ willingness to raise rates again if necessary, noting that gains from the stock market and rising housing prices might not be enough to curb demand and inflation.

S&P surveys last Thursday indicated that inflation remains a concern for businesses, contributing to a 605.78-point drop in the Dow Jones Industrial Average, its worst one-day decline in over a year. However, stock indexes rebounded on Friday despite consumer sentiment darkening due to inflation worries.

Michael Reynolds of Glenmede suggested that while the Fed might still need to hike rates, inflation will likely remain above 2%. A stock market correction may be needed given high investor hopes for lower borrowing costs.

Glenmede has adjusted its view from underweight to neutral on equities, balancing macro risks and advising clients to avoid major portfolio shifts ahead of the November election.

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