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A DOWNTURN COULD REALLY ROCK THE BOATPaper wealth has kept the economy riding high--so look out if consumers get nervousPat and Joseph Massucci, a fortysomething couple from Joliet, Ill., have just bought a new addition to their home recording studio--a $1,000 electronic drum set. Mark and Diane Shelley of Worcester, Mass., bought three new bicycles valued at $20,000 and spent another $6,000 on a cycling vacation. Most years, such spending would seem extravagant. But thanks in part to the bull market, says Mark Shelley, a 37-year-old software engineer, it isn't. ''We've met our investment goals for the year,'' he explains. The rest is gravy. The Shelleys and the Massuccis are classic examples of the ''wealth effect''--the feeling of financial well-being that turns ordinary consumers into big spenders. With the market swelling the value of their portfolios and with home values appreciating at double-digit annual rates in many areas, millions of families feel that they don't have to worry so much about meeting savings goals for retirement or college educations. So the savings rate has plunged to 0.2% of gross domestic product--while spending has surged at a 6% annual rate so far this year. ''The stock market has played a big part in people's confidence,'' says Steve Beers, manager of Keefe Real Estate Inc. in Lake Geneva, Wis., where multimillion-dollar homes are selling briskly. Until now, the spending spree has been a tonic for the economy. For the past year, even as the Asian crisis has deepened and U.S. exports have cratered, carefree consumers have kept the economy going strong. Last quarter, Americans shelled out money at an annual rate topping $5 trillion. After adjusting for inflation, that's 5.35% more than a year ago. In June alone, spending rose by 0.6%, three times as much as incomes. The splurging has helped all sorts of companies--from interior decorators to resorts to boatyards. ''If business keeps up, this will be the best year I've ever had,'' says Marcell Rogalla, who has been selling swimming pools in Barrington, Ill., for 26 years. In 1998, he expects to sell at least 175 pools at $45,000 to $50,000 each. But what happens now, when the market has suddenly dropped 9% from its all-time high, reached in July? What if the correction deepens and the upbeat psychology induced by the wealth effect gives way to an anxiety attack? If it means that American pocketbooks suddenly snap shut, it's bear time for the Goldilocks economy. ''With a correction, we could get a significant slowdown in consumption,'' warns Joel Prakken, chairman of Macroeconomic Advisers of St. Louis. Nobody knows yet whether the midsummer stumble will be enough to turn spenders into savers. But clearly, the jolting 299-point slide in the Dow Jones industrial average on Aug. 4--and the market's seesawing the next day--have millions of consumers eyeing the market with a twinge of concern. Bruce Steinberg, chief economist at Merrill Lynch & Co., notes: ''The U.S. economy is more sensitive to the equity market than it or any other economy has ever been.'' With interest rates still low, people may still buy that new car, but they might go for the Accord instead of the Lexus. And folks such as the Massuccis might hold off on discretionary spending such as that drum set. SLIPPAGE. In other words, the wealth effect works both ways. Economists figure that for every $1 rise in stock values, personal spending rises 4 cents. And thanks to the Wall Street boom, personal assets are up $7 trillion since 1996, according to the Federal Reserve Board. By the same token, a $1 drop in stock values slows spending by 4 cents--or perhaps a bit more. The market slide comes amid signs that consumers may be ready to take a breather. Consumer confidence dipped slightly in July, to 135.4 from 138.2. Credit-card balances in the first quarter were up 10% from the year before, and delinquencies were running at higher levels than they did in the last recession, according to Veribanc Inc., a bank research firm. Meanwhile, retail sales in June flagged a bit. Auto sales, which had been streaking toward a record, have cooled. Ford (F) reported a 4.3% drop in June sales, worse than expected. General Motors Corp. (GM), crippled by its lengthy strike, saw sales plunge 38%. The GM strike and the export slump clearly have hurt the manufacturing sector: The National Association of Purchasing Managers index, at 49.1, has dropped for four consecutive months. DELAYED REACTION. Few economists are even hinting about a recession anytime soon. But that forecast could change if consumers retreat as quickly as the market has. Mark Zandi, chief economist at Regional Financial Associates in West Chester, Pa., figures it would take a punishing 30% drop in stock prices, and an even worse Asia crisis, to produce a contraction in spending. Even then, he says, the reduction would happen over time. ''It takes up to two years after a change in net worth to feel all the consumption effects,'' he explains. Even if the market just stalls, though, there could be deeper consequences than a cyclical slowdown. Economists fret about the savings rate, which has plunged from 9% in 1982 to 2% last year as consumers have seen their retirement accounts swell with the market. And over the past year, the savings rate has gone from bad to alarming. Revised Commerce Dept. calculations show it fell to 0.2% in June. If the trend continues, it could have grave consequences when baby boomers begin retiring. Says M. Carey Leahey, chief U.S. economist at High Frequency Economics of Valhalla, N.Y.: ''Unless the market continues to deliver a 10% to 12% return, people aren't going to make it with what they are doing now.'' In part, the savings numbers look so grim because government economists calculate savings differently from the way real people do. For instance, Commerce excludes increases in the value of housing and leaves out capital gains earned on stocks and mutual funds. To most Americans, both are major sources of new wealth. But the paper wealth already has begun to vanish. If the market is merely in the midst of another in a series of pauses, consumer spending will probably remain solid. But if this is the Big One--the 20% or greater correction the bears have long been predicting--Wall Street could bring consumers, and much of business, down with it.
By Howard Gleckman, with Mike McNamee, in Washington, Ann Therese Palmer in Chicago, and bureau reports RELATED ITEMS
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Updated Aug. 6, 1998 by bwwebmaster
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