By Jack N., Communications Analyst and Blog Contributor
Investors and traders would be wise to understand the impact of the wealth effect, because it can move the economy and markets.
The wealth effect is an economic theory suggesting that people spend more money when they feel richer, even if they’re not necessarily richer. They also spend less if they feel poorer. I think there’s plenty of economic data showing that the country has gone through a protracted period of people feeling poorer (and, I’ll concede they might actually be poorer), and is moving into a period of people feeling richer.
You can track the wealth effect, for example, by looking at housing prices and consumer spending. As housing prices fell through the floor from 2006 through late last year, consumer spending, especially on non-discretionary items, slowed. But now housing prices are rising, and consumer spending is moving up. It’s not an explosion, but it’s headed in the right direction.
Thanks to ultra-low mortgage rates, some people will have more cash available. Take me, for example. I just bought a house at the crazy rate of 3.625 percent. (And rates are even lower today). Do you know what that means? It means that my household has about $400 extra a month.
And I’m not alone.
The sale of new homes has taken off, with construction rising in December to the highest rate in more than four years. That’s propelled the stock prices of home builders as well. The S&P Supercomposite Homebuilding Index, which consists of 11 U.S. home building companies, has risen more than 80 percent for the year ending Jan. 17.
I have no idea if that will continue. All I’m saying is that collectively throughout the country low mortgage rates are freeing up a lot of money that can be used to reduce debt (feeding the positive wealth effect), buy more stuff and invest.
We are inundated daily with negative economic and market news. You shouldn’t discount it. But don’t be paralyzed by it either. The improving wealth effect offers a potential foundation for optimism.
In Scottrade’s 2012 American Investor Survey, 77 percent of homeowners said a home was a good investment. Does this make you more likely to consider homebuilding stocks?
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