Why a strong stock market is propping up the economy and why a labor market shock could topple it

Stock market gains have become an unexpectedly important prop for the U.S. economy this year. Wealth effects from rising equity portfolios have supported household spending, corporate confidence and local government finances even as key measures of the real economy showed signs of cooling. That dynamic has allowed growth to outpace more pessimistic forecasts, but economists warn that the arrangement is fragile. A sharper deterioration in the labour market would cut into incomes and consumer confidence in a way that could quickly reverse the positive feedback loop from higher asset prices to economic momentum.

The link between markets and the broader economy is straightforward but often underappreciated in ordinary times. Gains in equities increase household net worth and raise the value of retirement accounts and brokerage balances. For high net worth households and older cohorts who hold a disproportionate share of stock market wealth, that uptick translates into greater willingness to spend on discretionary goods and services. Corporations, watching equity valuations, also feel more secure about issuing equity, repurchasing shares and embarking on investment projects. Municipalities with portfolios invested in equities or whose tax revenues are sensitive to asset related activity see fiscal relief when markets rally. All of these channels have acted in concert this autumn to cushion the impact of a slower employment backdrop.

How the market is underpinning demand

The recent rally in equities has lifted aggregate household balance sheets at a time when wage growth is moderating and some consumers are drawing down pandemic era savings. Higher asset values have helped sustain confidence measures among wealthier cohorts, who account for a large share of consumer spending in discretionary categories. That divergence is visible in national sentiment surveys where respondents with significant stock holdings report materially better outlooks than those without. Retail spending patterns reflect this split; travel, luxury purchases and premium services have held up better than basic goods consumption in parts of the country where investment gains are concentrated.

Corporate behaviour has mirrored household sentiment. Firms in sectors sensitive to confidence have delayed aggressive cost cutting and in some cases accelerated capital allocation decisions that support demand for business services and suppliers. The willingness of companies to proceed with hiring for strategic roles and to maintain marketing outlays has supported sectors beyond technology and finance. Equity financed buybacks and strategic M and A activity have continued in pockets, which further supports the market through reduced share float and positive earnings per share mechanics.

Local government finances also benefit indirectly from market strength. Jurisdictions that rely on investment income in pension funds see a slower growth in pension burdens when asset values rise, which can translate into steadier municipal budgets and fewer tax adjustments. That fiscal breathing room matters for schools, transport and infrastructure projects that employ thousands of workers and influence regional consumer health.

Yet this market led buoyancy is uneven and concentrated. The gains are primarily flowing to households and firms with substantial exposure to financial assets. For a wider set of consumers the picture is less sanguine. Wages have softened in several service industries and longer term job security concerns have increased in regions reliant on cyclical sectors. If labour market conditions deteriorate further, the benefits of higher asset prices could evaporate quickly for the broader population.

The labour market is the weak link

A robust labour market is the glue that keeps a wealth effect working for the broader economy. Employment income is the primary revenue source for most households. When unemployment remains low and wage growth continues, consumers feel comfortable spending even if they see market value swings in their portfolios. But when job growth slows and layoffs accelerate, the income channel tightens and financial market gains lose their potency as a demand driver.

Recent data through early November indicated signs of moderation. Headline payroll increases have slowed compared with last year and some surveys show a rise in hiring freezes and job cuts in select sectors. Firms that had front loaded hiring during earlier growth phases are now reassessing headcount in response to softer order books and elongated sales cycles, particularly among companies tied to enterprise technology and discretionary consumer demand. That rebalancing can initially be localised, but labour market weakness tends to spread through sectors linked by supply chains and regional labour pools.

A labour market breakdown would hit consumer spending in multiple ways. First, lost wages immediately reduce disposable income for affected households. Second, heightened unemployment increases precautionary saving among those still employed as fears about future job security rise. Third, a visible increase in layoffs undermines consumer confidence more broadly, inducing middle income households who do not rely primarily on capital gains to cut discretionary spending. Together those effects weaken aggregate demand in a way that is hard to offset with portfolio gains concentrated among the affluent.

The composition of recent job losses also matters. If layoffs are concentrated among younger, lower paid workers the immediate aggregate income hit may be muted relative to a broader retrenchment that includes prime age workers. However prolonged tightness in hiring or structural shifts in demand for certain skill sets can depress wage growth and labour force participation over the medium term, which would erode consumption power more persistently.

What policymakers and investors should watch and how to prepare

Policymakers face a delicate balancing act. Central banks must weigh signals from financial markets, labour market indicators and inflation data to set monetary policy that preserves price stability but avoids inducing an unnecessary recession. If the labour market shows sustained weakening that translates into falling wage pressures and lower services inflation, policymakers could justify easing. But if labour weakness coincides with falling demand and lower inflation that suggests a need for fiscal support to prevent a damaging spiral.

Fiscal authorities can act more directly to stabilize incomes through targeted measures such as extended unemployment benefits, support for local government budgets or temporary tax relief for lower income households. Those measures shore up demand quickly because they flow directly to those with high marginal propensity to consume. In the current moment the political and budgetary room for large scale fiscal responses is constrained, which increases the importance of timely and targeted interventions if the labour market begins to crack.

Investors should adjust portfolio risk and liquidity plans to account for scenarios in which labour market weakness propagates beyond the most affected sectors. For those with multi year horizons the recent correction in certain high momentum sectors may present buying opportunities, but only after assessing the risk that slower employment and income dynamics reduce corporate earnings across cyclical pockets. For shorter term traders and institutions, hedging around key macro data releases and maintaining cash buffers can mitigate the market wide impact of a rapid sentiment reversal.

Market watchers will be focused on a handful of indicators that are likely to presage trouble. Initial jobless claims are a sensitive early indicator of rising layoffs. Wage growth metrics and measures of labour force participation provide signals about underlying resilience. Consumer sentiment surveys that disaggregate respondents by wealth and employment status can reveal whether asset gains are broadly supporting confidence or whether the effects remain narrowly concentrated. Lastly, corporate guidance on hiring, backlog and margins will indicate whether firms expect demand to hold or to deteriorate.

For now the stock market has done more than enrich portfolios. It has supported a fragile expansion by improving balance sheets, lifting confidence among wealthy households and reducing some fiscal pressures at the local level. But that support is not a substitute for broad based labour market strength. A breakdown in employment conditions could rapidly extinguish the benefits conferred by higher market values, creating a cascade of income losses, precautionary saving and weaker consumption. Policymakers and investors must therefore watch labour market signals closely and be prepared to act if the tenuous link between asset prices and real economic momentum starts to fray.

Written by Nick Ravenshade for NENC Media Group, original article and analysis.
Sources: CNBC, University of Michigan Surveys of Consumers, Bureau of Labor Statistics, Financial Content MarketMinute, Economic Times.