Economic Trends
By Gene Koretz
Home, Sweet Nest Egg
Remember the infamous "negative wealth effect"? Just as soaring stock prices purportedly induced households to spend wildly and stop saving during the boom, so the subsequent market debacle was supposed to touch off a sharp slowdown in consumption.
It never happened. Despite the onset of recession and a $4.2 trillion plunge in consumers' net worth in recent years, the savings rate remains low and consumer spending has stayed remarkably buoyant. The wealth effect, it seems, has lost its punch.
Or has it? According to Mark M. Zandi of Economy.com Inc., wealth shifts still have a big impact on consumption, but the rise in housing values seems to have largely offset the decline in stock market wealth. Economist Ian Morris of HSBC Securities Inc. agrees, noting that home resale prices, at last count, were up 8.4% year over year (chart).
Until recently, many experts doubted whether shifts in housing wealth can affect consumption as much as changes in financial wealth. Homeowners presumably have a harder time estimating the value of their houses than their stock portfolios. And many may not regard their homes as appropriate for funding current spending.
A recent National Bureau of Economic Research study by Karl E. Case, John M. Quigley, and Robert J. Shiller finds, however, that the wealth effect of real estate values has been seriously underestimated. Based on an analysis of annual data from 14 countries and quarterly data from a panel of U.S. states, the results suggest that the housing market appears to be far "more important than the stock market in influencing consumption," both in the U.S. and other developed nations.
One likely reason for this in America is the concentration of stockholdings, with 10% of households owning more than three-quarters of all stocks. By contrast, more than two-thirds of U.S. households own homes, and many count them as their largest asset. And homeowners have been more willing to tap into the rising values of their homes, as mortgage refinancing and home-equity borrowing have become easier and more popular.
Much of the credit for today's buoyant housing market, of course, belongs to Alan Greenspan's interest-rate cuts. Now, with signs that rates may soon start trending higher, a key question is whether housing will falter in the months ahead. Zandi thinks any weakening will be limited. Morris, however, notes that strong price rises could turn into a bubble whose eventual bursting would undermine the recovery. If we're lucky, he says, "home prices will simply lose some steam as lagging sectors of the economy finally kick in."
The True Value in Value Stocks
Copious research has established that so-called value stocks, which have low prices relative to such variables as earnings or book value, tend as a group to consistently outperform both the overall market and glamour stocks with high price multiples.
In a study of some 14,000 value stocks (with prices running around 40% of book value) from 1976 to 1996, Joseph D. Piotroski, an accounting professor at the University of Chicago's Graduate School of Business, found that this superior performance is driven by just 25% or so of his sample. More than half the group trailed the market, according to the study, which appeared in a recent issue of The Journal of Accounting Research.
Could an assiduous investor identify prospective big winners? To find out, Piotroski constructed a "financial health" report card using information gleaned from corporate financial reports. He reports that value companies with positive grades on at least eight of nine variables relating to their financial conditions--such as trends in earnings, cash flow, profit margins, and asset turnover--tended to outperform the market by 13 percentage points. That is, over the period studied, portfolios consisting of such companies (usually about a tenth of value stocks) yielded one-year market-adjusted returns averaging 13.4%.
Piotroski concludes that value investors willing to pore over companies' financial statements could reap some nice rewards--particularly in the case of smaller companies that are thinly traded and followed by few analysts.
Higher-Ups Are Getting the Ax
In economic downturns, it's usually the worst-paid groups, such as the less educated workers, who are first to lose their jobs. And, of course, they're the last to be rehired when the economy turns up. In the current recession, however, higher-earning groups appear to have suffered at least as much in relative terms as those toward the bottom of the income pole.
For example, recent Labor Dept. analysis found that employment in the highest-earning occupations--managers, professionals, and technical types--fell by about half a million between the first and fourth quarters of last year. Meanwhile, jobs in the bottom third of occupations, encompassing lower-paid, unskilled jobs, declined by only 200,000. Indeed, economist Howard J. Wall of the Federal Reserve Bank of St. Louis notes that the unemployment rate among college grads--but not among less-educated workers--is now above its average 1994 level, before the boom started (chart).
In sum, thus far the pain of lost paychecks appears to have affected low-wage workers less and higher-wage folks more than in past recessions. And with signs that a recovery may be at hand, that at least raises the hope that the ranks of the disadvantaged may be able to weather the current economic storm better than many observers have feared.
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Copyright 2002 , by The McGraw-Hill Companies Inc. All rights reserved.
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