In an article published yesterday, I explained why it is highly unlikely the Fed's latest round of stimulus will trigger the so-called 'wealth effect.' The logic behind my argument is quite simple: as long as interest rates are artificially suppressed, any new 'wealth' generated by the Fed's asset purchases will be used to replace income lost to low rates on savings vehicles. Additionally - and in keeping with a similar analysis presented by Morgan Stanley - I noted that slow real income growth exacerbates this problem.
In short, the Fed's policy is self-defeating: large-scale asset purchases drastically decrease income from savings accounts, money market funds, Treasury bonds, etc. by driving down interest rates, thereby ensuring that higher stock prices and home prices will serve only to offset lost interest income, and will not (indeed cannot) bring about an appreciable increase in consumer spending.
On Friday, investors got a look at all three economic data points cited above: consumer spending, real disposable income, and personal savings. The numbers support the contention that the wealth effect has very little chance of getting any traction. Consumer spending rose by the most in six months (.5%), but the increase was attributable to higher gas prices as spending rose only .1% after adjusting for inflation. As CNBC notes,
"...that suggests growth in consumer spending is unlikely to improve much this quarter from the tepid 1.5 percent annual pace recorded in the April-June period."
Meanwhile, real disposable household income dove .3% in August, the first decline in 9 months. As for the final variable in the wealth effect equation, the personal savings rate dropped .4% to 3.7%, the lowest rate in four months.
These data points suggest that the chances of there being an appreciable increase in consumer spending (ex gasoline) brought about by the Fed's asset purchases are very slim indeed. With gas prices elevated, it is likely that the increase in spending on gasoline will exceed income growth, leading directly to further decreases in the rate of personal savings.
Furthermore, the meager amount Americans do manage to save will generate next to nothing in terms of returns thanks to the Fed's zero interest rate policy. In light of this dynamic, I recommend remaining skeptical regarding the prospects for a consumer-led economic recovery. Investors can capitalize on their apprehensions by betting against consumer discretionary names (Consumer Discretionary Select Sector SPDR ETF: XLY) and the S&P 500 (SPDR S&P 500 Trust ETF: SPY).