The ‘Wealth Effect’ Takes a Hit as Highest Earners Start Fearing Recession

On a day when headline inflation reports showed prices increases stubbornly staying about 8%, a deeper dive into the impact that figure is having on the psyche of spending is warranted, as high-earning, wealthy consumers are joining the less affluent in adopting a more cautious stance and outlook.

This, as the stock market is down 25% year-to-date, real estate prices retreating, interest rates on the rise and prices continuing to climb with 40-year record inflation threatening to burst into open recession.

At some point even the more monied among us start sweating a troubled economy, as seems to be the case in the fourth quarter of 2022. Even as the U.S. Bureau of Labor Statistics (BLS) released September pricing data on Thursday (Oct. 13) showing another month-over-month rise in costs, some Wall Street stalwarts began to show inflationary stressors.

Per the BLS numbers released Thursday, prices for everything except gas, used cars and apparel rose again in September, coming in at 8.2% this year through September, which is an incremental improvement from August’s 8.3% rate, but at a more accelerated rate.

As was widely reported, Citi analyst Arren Cyganovich downgraded American Express to Sell from Neutral, saying in a client communiqué that “While the recession is projected to be mild, the impact to our EPS can be rather large as we are coming off of record low credit losses and are now forecasting slightly higher than normal credit losses in 2024.”

Underlying this is “the wealth effect,” an economic theory positing that the more financially secure people feel, the more money they spend in both amount and frequency.

PYMNTS’ Karen Webster analyzed downsides of this in “Why Retailers Should Worry About Inflation but Dread the Wealth Effect,” acknowledging the impact of inflation on lower earners, and saying “it’s the wealth effect that is the more important determinant of whether consumers with money to spend will actually open their digital wallets and spend it.”

She added, “That’s particularly true for high earners — they have probably had the greatest proportion of wealth destroyed, in part by the massive drop in stock prices, and they could be hit more if the continued decrease in housing demand sends housing prices south. Because high earners account for so much of the retail economy, their pull-back in spending could be the most damaging to it.”

We saw evidence of this starting in summer, with PYMNTS reporting, “The share of high-income consumers living paycheck to paycheck increased by nine percentage points in June. The survey found that the share of consumers earning more than $100,000 a year who were living paycheck to paycheck leapt from 36% in May to 45% in June.”

Underscoring that, new PYMNTS data being published in October finds that 42.5% of those earning over $100,000 per year believe that the economy is already in a recession.

See also: $100K+ Households Saw Biggest Increase in Paycheck-to-Paycheck Living

Secure No More

While luxury retail has continued to perform well in the face of inflation this year, recession is another matter, and high earners who often have stock holdings to match are starting to get spooked as the value of their investments decreases, inevitably leading to belt-tightening.

According to the PYMNTS study “Consumer Inflation Sentiment: Inflation Slowly Ebbs, But Consumer Outlook Remains Gloomy” based on surveys of close to 2,200 U.S. consumers, “Overall, 32% of consumers expect their financial standing to worsen in the next year, down ever-so-slightly from 35% in July,” a statistic that includes high earning Americans.

That report added, “Consumers say that the rising cost of essentials such as groceries, housing and fuel forces severe cutbacks on discretionary spending, and 70% of the surveyed consumers who made retail purchases have cut down on nonessential retail spending,” with 61% of those surveyed saying their households cannot handle any further price increases.”

Insulated from 2022 price hikes until now, wealthier Americans are likely to begin cutting back in their own way, be that the lower priced SUV or a high-end vacation not taken.

As Webster wrote, “Some dismal scientists worry that future stock market and housing market instability at the levels experienced in the first half of 2022 could further weaken those household balance sheets and dent GDP growth. Why? Because consumers may not spend — even those with money in their accounts who could spend — unless they feel confident that their financial situation is secure.”