How the ‘wealth effect’ shapes US markets now

It may be that US economic exceptionalism has become self-reinforcing. That’s one way that Chhad Aul, Chief Investment Officer and Head of Multi-Asset Solutions at Sun Life Global Investments in Toronto, views the uniqueness of US markets and the US economy relative to its developed market peers. He believes that one of the core drivers of US economic growth, US consumer spending, US inflation, and US equity performance has been the strength of its markets and the growing wealth of US asset owners.

Aul calls this phenomenon the ‘wealth effect’ and says that it’s been key to how the US has weathered inflationary shocks and market swoons. He outlined how this shift from the economy driving the market to the market driving economy introduces certain risks and opportunities for investors. He highlighted how the wealth effect may inform US Fed policy going forward and how the economic inequalities that it could reinforce may introduce new risks for advisors to be aware of.

“You’re seeing more and more of this element, not always that the market is a reflection of the economy, but the market can actually drive the economy through that wealth effect. And I think that’s become quite strong in the last number of years, taking a leg higher in terms of that further participation in the equity market,” Aul says. “We’ve seen moments post-COVID where consumer confidence drops off quite significantly with higher oil prices, but when you actually look at the hard data, like retail spending, that has held up much better than expected. People are saying they’re upset about different economic impacts, they’re feeling less confident, but at the end of the day, they’re still spending. And we tie a lot of that back to the fact that the equity markets continue to push through new highs.”

Market performance as Fed policy?

As equity markets now play an outsized role in the US economy, Aul and his team have found that a sustained 10 per cent market correction would result in a loss of household wealth equivalent to roughly 14 per cent of US GDP. That connection could make the so-called ‘Fed put,’ which posits that the US Federal Reserve will intervene in the case of severe market downturns, an essential part of US economic policy.

While US policymakers may be incentivized to support and backstop market performance, US inflation still remains above the Fed’s stated target range of two to three per cent. That higher inflation and the more terse and hawkish tone set by new Fed Chair Kevin Warsh, has some analysts predicting that US interest rates will remain ‘higher for longer.’ Aul notes, however, that we shouldn’t view contemporary rates as ‘higher,’ but rather look at the regime of near-zero interest rates that came before them as abnormal. Where US interest rates sit today is closer to the historic bounds of normalcy, giving the Fed capacity to support markets or the economy with rate cuts if needed.

Inequality and the ‘K-shaped economy’

One of the features of the wealth effect in the United States is that it has exacerbated wealth inequality. Those who own assets, or earn enough to invest a meaningful part of their incomes have enjoyed market outperformance and expansion of their wealth, which has enabled them to consume and invest more. Those who don’t own assets and who don’t earn enough to invest, don’t participate, which exacerbates the so-called ‘K-shaped economy’ where a small cohort at the top do better, drive growth, and drive spending while a significant body of Americans find themselves worse off.

Should the upper leg of the K start to weaken and see their spending or asset growth collapse, there could be a risk for the wider US economy and equity market. Aul is measuring that risk by looking at the labour market, with the view that if upper income job losses become more acute then we may see the beginnings of a downturn in the wider US economy.

There is also a degree of political and policy risk that could be introduced by growing inequality, especially in an election year. Aul notes that US politics introduces layers of complexity that advisors and asset managers are best served by avoiding, but that most of the populist policies built around inequality now are more directed at billionaires and the top 0.1 per cent. Possible risks to the wealth effect, he says, would only take hold if policies were enacted targeting the wider mass-affluent base of asset owners.

Opportunities and advisor messaging

For Canadian advisors looking at a self-reinforcing US market, Aul says there may still be compelling reasons to own US assets. He notes that in 2025 a global rotation took hold and while that’s continued somewhat this year, as time has passed the US has reasserted its importance in global equity markets. He argues that advisors may look at the strength of US performance, American leadership in innovative areas like AI, and the essential role of the US in the global economy as reasons to maintain or even add to their US exposures, even as they  

“The US is still the largest, most dynamic economy in the world. The US dollar has a very unique place and I think that is something that an advisor can certainly explain to investors,” Aul says. “When there’s turmoil typically, and in many, many scenarios tested over time, there will be a flight to safety on the US dollar, which gives you some nice diversification, some downside protection when you’re investing in US assets. If you put together those pieces and you do not want to stray too far from your allocation in the US, have your opportunities there, but recognize that there are more and more emerging opportunities beyond just that one large economy in the world.”