Household net worth in the United States surpassed $90 trillion for the first time in Q3 2016, according to the latest estimates from the Federal Reserve’s Financial Accounts of the United States (Z1). That’s up sharply from $67.9 trillion now estimated (with revisions) for Q3 2012 when QE3 was introduced. Despite a massive gain of just about a third, Nominal Final Sales to Domestic Purchasers (from the BEA’s GDP data) have increased but 14.5%, a pathetic (nominal) 3.4% compounded annual rate.

We should not expect a dollar for dollar increase in spending for paper “wealth”, of course, but if this QE “wealth effect” was as efficient in the past almost five years as it was, theoretically, during the worst of the dot-com bubble, Nominal Final Sales to Domestic Purchasers would be $2 trillion more in the latest quarter. That would have been a 26% gain in final sales since QE3, or 6.1% compounded, nearly twice the rate above what actually occurred.

abook-dec-2016-net-worth

It should be painfully clear even to economists that there is no wealth effect, especially where paper “wealth” is involved as a matter of arguable imbalance (i.e., asset bubbles). There is no detectible relationship between net worth and spending, even though by common sense there might be. To the left, that is a function of “inequality”; to the right, a matter of income distribution; to Economists, it’s the Baby Boomers.

Whatever the interpretation, this should remove asset prices from all economic considerations, particularly those of monetary policy. My own view is that it was never a strong appeal in terms of inside policy discussions, more so included in outward proclamations and literature solely because it was practically the only way to assign any success at all to the QE’s. The US and global economy failed to ignite in embarrassing fashion, especially after 2014, so at least economists had stock and housing prices (the main components of household net worth) with which to suggest a minimum of QE achievement.

Obviously, if consumers don’t respond in spending or “aggregate demand” due to asset prices (at least in the positive; we know very well the asymmetry of net worth that is outright contracting, as in 2008-09), it is yet one more piece of statistical evidence that shows the denominator in the unemployment rate as the part of that ratio determining the economic course. In other words, it is income not wealth; and all theory aside, more wealth does not lead to more spending that creates a trickle down of income growth. Perhaps under different circumstances that could be the case, but it is abundantly clear that in the past two decades there isn’t a good or even arguable correlation.

abook-dec-2016-net-worth-to-final-sales

If there has been a common factor against the “wealth effect” it might be somewhat parallel to Milton Friedman’s permanent income hypothesis. Friedman stated that consumers don’t react to temporary increases in their nominal pay, realizing that after whatever relevant period of time their earnings will just go back to whatever they were before. Under those terms, people were/are far, far more likely to save (including paying down debt) that income windfall as spend it.

In the case of asset bubble-type “wealth”, I wonder if there is a similar property related to valuations. In other words, most people recognize the fragility of market prices at the extremes, all bubble rationalizations included. Nobody expects to be left holding the bag when the inevitable comes, of course, but realizing that someone will have to take losses at some point engenders, perhaps, more care and concern with how consumers “feel” about their paper net worth gains.

The housing bubble of the last decade was the glaring exception. Many, many Americans “spent” the equity windfall via mortgages and flipping. It was a punishing exercise that may help explain why this time around there is even greater reluctance to treat price gains whether stocks or houses in similar fashion.

In terms of just equities, even though valuations have come back over the past few years, they remain historically elevated. Also contained within the Financial Accounts of the United States are the ingredients for Tobin’s Q ratio, as well as a modified ratio that subtracts corporate real estate assets at market values from corporate net worth (as the denominator in the Q ratio).

abook-dec-2016-net-worth-tobins-q-modified-revisions

By this valuation technique, the “cycle” extreme was reached in Q1 2015. The “global turmoil” that erupted shortly thereafter in stocks appears to have had the effect of drawing down the fringe of overall valuations. But the primary reason for that was as much that denominator as the value of corporate equities in the numerator. The Z1 accounts estimate that Corporate Net Worth, unlike Household Net Worth, was almost entirely undisturbed over the past few years. It continues to rise regardless; shifting only for the various quarterly revisions to the series.

abook-dec-2016-net-worth-corp-net-worth

It’s an interesting development where the Fed suggests corporate net worth hasn’t been changed by all that has taken place not just under the “rising dollar” but also since 2011. It is, to me, an absurd expectation especially as it is being driven by cyclical considerations that don’t exist. One reason for that is corporate balance sheets remain insulated as part of the ongoing credit “cycle.” There are and have been no systemic impairments with which to suggest to the statistics an inflection in net worth, but that only means reported Net Worth could be considerably different than what is really taking place (think energy sector).

During the Great Recession, for example, Corporate Net Worth contracted by nearly 25%; not as a matter of immediate circumstances alone, but also in rethinking balance sheets as they had developed in the years before it. That was, of course, an extreme circumstance, and nothing like what might be indicated here. Even during the dot-com recession, however, Corporate Net Worth declined very slightly at its start, but then failed to grow for the next two years. There are numerous indications apart from a credit “cycle” that the current global economic environment is as bad as 2001-03, if not in some places slightly worse. If the Z1 accounts were to “write down” corporate impairments as if that was the case, valuations look very, very different.

abook-dec-2016-net-worth-corp-net-worth-impaired-whatifabook-dec-2016-net-worth-tobins-q-impaired-whatif2abook-dec-2016-net-worth-tobins-q-impaired-whatif

It would suggest valuations that would be comparable only to the top of the dot-com bubble. And that difference is due entirely to the fact that the Federal Reserve’s Z1 statisticians have modeled a rather healthy, large $2.5 trillion increase, +12.5%, in Corporate Net Worth just in the seven quarters since the end of 2014. In my analysis, it is, again, an absurd proposition given everything that has transpired during those seven quarters and what it has meant for global economic opportunity and financial balance.

We know that is likely the case given how businesses in the US have responded; like households, they sure aren’t acting like net worth is much positive comfort, as the broader range of employment data indicates broad corporate restrictions and slowing in labor utilization.

abook-dec-2016-jolts-hi-recentabook-dec-2016-lmci-ratchet

The economy where QE worked at least through the “wealth effect” remains totally absent, leaving the economy of the past few years in significantly worse shape. But the net worth of US corporate businesses is estimated to have been unbothered by all that, figured to reflect pretty much the economy where QE worked. Therefore, in this valuation technique, it is suggesting stocks may still be overvalued, just not to the ridiculous levels which might be indicated had net worth been more realistically modeled, in my view, by estimates more consistent with how the economy actually has been (and looks set to remain).

There is clearly no wealth effect, but some part of that “wealth” is being justified anyway as if there was. Another sign of the times.