Bank of the West US Outlook Report for August 28, 2015

Global investor confidence rapidly eroded this week before recovering some poise by week end, doing noticeable damage to global and U.S. stock market wealth. The selling pressure was mitigated temporarily as China jumped in on Tuesday with across the board 25-basis-point cuts to their monetary policy rates, the 1-Yr lending and deposit rate. This was the fifth cut in these rates since last November.  At the same time, the People’s Bank of China cut their reserve requirement ratio by 50 basis points.  But in the end, it wasn’t enough to end concerns about the near-term global outlook or staunch the decline in China’s stock market, which continued to drop as Chinese authorities refused to prop-up the stock market with direct actions.

Since June 14 through Wednesday’s close, China’s stock market capitalization had dropped by almost $5.2 trillion dollars – a stinging drop of 51.4%. But to keep things into perspective that was the level of China’s stock market capitalization only a few months ago-back in January of this year.

By comparison, U.S. stock market wealth declines have been smaller. The U.S. market capitalization has fallen $2.75 trillion since the June all-time peak.  Moreover, since the February 2009 low, stock market capitalization in the U.S. has still increased by $13.74 trillion (+157%) even with the losses chalked-up over the past month and a half. Assuming a wealth effect of a 2 cent decline in consumer spending over the next two years for every dollar lost in the U.S. stock market (an historical rule-of-thumb), we arrive at a hit to nominal consumer spending of around $55 billion over the next 24 months.

It’s possible, the negative economic impact on the U.S. economy could be somewhat larger than the pure wealth effect implies, especially if the global economy enters into a full-blown recession, hitting U.S. exporters. Or if psychologically traumatizing consumers and businesses lose their confidence in the economy and respond by raising savings rates and cash and delaying planned spending.

Thankfully, that does not appear to be the case yet as U.S. consumer confidence jumped in August with the present situation component hitting expansion highs despite the recent market turmoil.  An improving labor market appears to be trumping stock market price declines in consumers’ minds so far.

We will also be closely monitoring global liquidity conditions and corporate credit spreads for any signs the global equity market selloff is creating strains other parts of the financial or banking system.  For now, it appears strains are minor compared to what we saw happening in 2008-2009 during the Great Recession.  This should not be surprising as bank’s are better capitalized and consumers and businesses are not as leveraged as they were in 2008.

Also, don’t forget the tailwind of lower oil prices for U.S. consumers.  If oil prices were to stay near current levels the net add to real consumer spending could be as high as $150 billion over the next two years.

Lastly, the large upward revision in U.S. real GDP growth in the second quarter with upward revisions to nearly all components of final sales underlines the resilience of the U.S. economic expansion and sets up the U.S. economy for another decent quarter of 2.7% annualized growth in the third quarter. While it now appears likely the recent market volatility and concerns for global growth and low inflation will scare the FOMC into delaying a Fed rate hike for a month or two, my vote would still be for a September initial increase.

To find out more, check out this week’s US Outlook Report.

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