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Dow Jones record may boost spending by wealthy; others still wary

The trading floor of the New York Stock Exchange is seen ahead of the closing bell in New York on March 5, 2013. REUTERS/Brendan McDermid
The trading floor of the New York Stock Exchange is seen ahead of the closing bell in New York on March 5, 2013. REUTERS/Brendan McDermid

By Steven C. Johnson and Ashley Lau

NEW YORK (Reuters) - About an hour after the Dow Jones industrial average hit a record high on Tuesday, Overland Park, Kansas-based financial adviser Brad Stratton got an e-mail from a client asking how she could "make hay while the sun shines."

Stratton, a former Merrill Lynch broker who set up his own firm last year, said he's been fielding a lot of such calls lately. Many are from clients who want to capitalize on stock-market gains by purchasing second homes or investment properties.

"They're seeing opportunity, both as an investment and as a lifestyle change," he said.

With U.S. stock market indices more than doubling since the financial crisis and the American housing market recovering, there are increasing hopes on Wall Street that a wider "wealth effect" could set in. That would see people with stock portfolios and homes feeling richer and more confident, prompting them to spend more on everything from home improvements to luxury cars and meals in restaurants, creating jobs in the process.

The Dow hit a record closing high on Tuesday, part of a broad market rally that has lifted the oldest U.S. market gauge nearly 9 percent so far this year. The achievement is particularly noteworthy given it is set against a background of government spending cuts and tax increases.

Solid corporate earnings, unprecedented support from the cheap money policies of the U.S. Federal Reserve and signs of improvement in the U.S. economy have helped investors overlook concerns about measures to rein in the government's budget deficit and still-high unemployment.

The stock market's gains will be felt disproportionately by the wealthy.

Ric Edelman, a Fairfax, Virginia-based independent financial adviser, said one of his clients called this week and asked him to send $62,500 because he had decided to buy a Porsche.

That client, Edelman said, was reluctant even to buy a used Corvette for $10,000 just a few months ago, but he had since realized that his portfolio gains mean he could afford to spring for the car he really wanted.

"He now accepts the fact that he can afford it and fell in love with the car and decided to buy it," said Edelman, who spoke to the client while he was at the dealership. "There was no way he would have done that before."

THE RICH AND THE REST

At the Miami Boat Show in mid-February, enthusiasts were throwing money around again this year in ways not seen since before the financial crisis, said Stephen Heese, chief executive of premium power boat builder Chris-Craft.

"In general they want to live their life and they're tired of austerity," Heese said of his customers, adding he expects sales growth in the order of 25 percent this year. "They're back to wanting to reward themselves."

Chris Craft's boats range in price from $50,000 to $600,000, with an average price of about $200,000.

Similarly, Cristina Mariani-May, co-CEO of Banfi Vintners, said the winemaker's luxury vintage, Poggio alle Mura Brunello di Montalcino, which costs about $75 retail or about $150 at a restaurant, has been selling well over the past six months.

"We can't produce enough. What we've seen is that people were holding back for a while, buying an entry (less expensive)bottle, but now we're seeing that they're going back to the luxury," she said.

Certainly, Americans generally have stronger personal balance sheets than they did just before the financial crisis. The household financial obligations ratio, a measure of the ratio of debt payments, car payments, insurance and property tax payments to disposable income fell to 15.74 percent in the third quarter of 2012, according to the Federal Reserve, down from a peak of nearly 19 percent reached in the third quarter of 2007, just before the market hit its last top.

The Fed's commitment to stimulus policies, through record low interest rates and its quantitative easing program of bond buying, has been a big reason for the market gains. Writing in defense of the central bank's easy money policies some two years ago, Fed Chairman Ben Bernanke said stocks would be an indicator of its success.

"Higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending," he wrote in the Washington Post in late 2010. "Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion."

Economists say that sentiment does seem to be improving.

"It's already the case that people are feeling a little better, and one of the reasons the consumer hasn't cooled off in the face of higher taxes is that they are starting to feel the benefits of higher home and equity prices," said Ethan Harris, chief U.S. economist at Bank of America Merrill Lynch.

Yet so far, not much of this has translated into hiring that would lift the broader economy. While the jobless rate has drifted lower since hitting 10 percent in 2009, it remains at an uncomfortably high 7.9 percent. And many of the unemployed have been so discouraged that they haven't been looking for work and don't count in the official rate.

MISSING INGREDIENT

The missing ingredient, many say, is corporate spending. Despite strong earnings and sales, non-financial U.S. companies had $1.7 trillion of liquid assets, or cash, on their books at the end of the third quarter.

"Corporate engagement has been a real disappointment," Harris said. "Corporations are in great health and have been for a few years but haven't been engaged. If you get them back, that means more jobs, which would helps make consumers more confident, and then we would get another wave of growth."

The housing sector is also far from fully recovered. While home prices have been rising since February 2012, more than 20 percent of mortgages are underwater and foreclosure rates remain elevated.

And the wealth effect from higher stock prices may not be very pronounced in many middle-income families as their savings are often concentrated in retirement accounts rather than active brokerage accounts, said Mark Zandi, chief economist at Moody's Analytics.

"It's one thing when you see wealth on paper and quite another when you actually see it in your checking account, sitting there for you to spend," Zandi said.

Meanwhile, many people are still wary of trusting gains in the stock and housing markets after getting hammered in the financial crisis, suggesting the wealth effect produced by those sectors has been greatly diminished, said Henry Mo, a U.S. economist at Credit Suisse.

In a study he co-authored, Mo found that between 1993 and 2012, 1 percent gains in housing and stock market wealth explained just 3.3 percent and 1.1 percent of gains in household consumption, respectively. But the 1993-2007 range showed gains of 5 percent and 3.3 percent, respectively, he said.

The increased volatility in the past few years hurt confidence in middle- and lower-income households, he said. Also, memories of the stock market decline and its aftermath caused many investors to simply miss the subsequent recovery.

While money has poured into equity mutual funds over the last few months, that's been barely a drop in the bucket when compared with the roughly $400 billion that had been pulled out in the preceding years.

"It demonstrates once again that investors have been in the wrong asset class," said Tobias Levkovich, chief U.S. equity strategist at Citigroup. "They've stayed in a defensive posture, buying bonds."

(Additional reporting by Martinne Geller, Lauren Young, Lisa Baertlein and Jennifer Ablan; Editing by David Gaffen, Martin Howell and Tim Dobbyn)

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