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The wealth effect had been keeping along with the long term upward trend of US equity market before the turbulence in Feb. Right now it seems that the trend is reversing based on the sharp decline of market since Feb18 given multiple uncertainties lingering, which is disrupting the confidence of investors substantially.
The impact of the US stock market on the economy is profound, not only directly affecting household consumption and corporate production through wealth effect channels, but influencing corporate refinancing through financial channels and affecting confidence in the financial market.
The academic research on the wealth effect of the US stock market generally believes that 1 US dollar corresponds to around 2.8 US cents. Using the US household balance sheet, it is estimated that a 10% decline in the US stock market could affect annual consumer spending by 1%.
Since Feb18, US stock market experienced a significant sell-off mainly caused by policy uncertainties from Trump administration which is shaking the confidence of investors substantially. S&P 500 has fallen by about 6% in the past two weeks, Nasdaq has fallen by over 11%, and the stock prices of tech giants such as Tesla and NVIDIA have plummeted by more than 20%.
According to the related data, this round sell-off resulted in the $2.7trillion losses in market cap, on average each family which holds equity via 401k loses $30k, which is absolutely a big loss and will have a significant impact on consumption. Consumption is the core engine of US economy. For every 1% decrease in consumer spending, the capacity utilization rate decreases by 1.2 percentage points, which will further result in relatively idle production capacity for enterprises, while the stock market downturn will lead to an increase in financing costs for enterprises. Maybe it is not an overstatement to say that US wealth effect is shrinking, the ripple effect will be obvious down the road.Complete digital access to quality Glebors financial topic with expert analysis from industry leaders.
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