The stock-market correction in recent weeks is more than a potential symptom of a slumping economy. It could cause a slump.
After cheering President Trump’s re-election in November, the market has sunk as investors worry that the White House’s aggressive and fast-changing tariff war could scuttle a soft landing. On Thursday, the S&P 500 closed down more than 10% from its February high, meeting the rule of thumb for a correction. It gained back some ground Friday.
The mood has already turned gloomy, but the market drawdown might be just the start of a chain reaction that causes more collateral damage. The Harvard economist Gabriel Chodorow-Reich estimates that with all else equal, a 20% drop in stocks in 2025 might reduce growth by as much as a percentage point this year. The S&P 500 at Friday’s close was down 4.1% so far in 2025.
Falling stock prices could siphon the fuel out of two key engines of recent U.S. prosperity: robust spending by households and capital investment by businesses.
“In a hyperfinancialized economy like America’s, asset prices can lead the economy, not just the other way around,” said Alex Chartres of Ruffer, a British fund manager. “A decline in asset markets creates the risk of weakening conditions in the real economy.”
The S&P gained 53% over 2023 and 2024, both reflecting and sustaining a strong economy. Alongside higher home prices, stock gains handed the wealthiest Americans more funds for a shopping spree. The top 10% of American earners now account for roughly half of all spending, up from 36% three decades ago, according to Moody’s.
As of 2022, families in the top 10% of income, on average, each owned about $2.1 million of stocks, about 32% of their net worth, according to a recent Federal Reserve survey. In 2010, stocks made up about 26% of average net worth for this group. Over the past four years, this group of top-10% earners has boosted spending by 58%.
It is not just the best-off who are pouring into stocks. Vanguard and Fidelity report record participation and contributions to their 401(k) plans for wage earners. At the end of last year, 43% of American households’ financial assets were in stocks, the highest share ever, according to Fed data. Many lower-income households don’t own equities, but the proportion that do continues to climb.
That is why some economists fear a serious market rout could push Americans to cut back on everything from vacations to new clothes, a swing called the wealth effect. If stocks had merely held steady last year rather than rallying, consumer spending would have only grown about 2% last year instead of the 3% partially fueled by the stock-market wealth effect, Deutsche Bank economists estimate.
Some signs suggest spending might be sagging already. Companies including Delta Air Lines, Foot Locker and Brown-Forman, maker of Jack Daniel’s whiskey, have all said consumers seem more cautious. In January, retail sales fell 0.9%, the biggest monthly decline since 2023, but some economists blamed unusually cold weather. February data is to be reported Monday.
On Friday, the University of Michigan reported that consumer sentiment had fallen to its lowest level since late 2022, in part owing to lower expectations for personal finances and the stock market.
Many people have a rough dollar target in mind for retirement. So if falling stocks make it harder to reach that target, consumers could cut back on spending to make up the difference, said Matthew Luzzetti, Deutsche Bank’s chief U.S. economist.
Luzzetti cautioned that this projection is challenging because the economy is so dynamic. But if little else changed, a 20% decline in stocks might produce a 1.2-percentage-point drag on consumer spending in 2025, he said. Because consumption comprises about 70% of gross domestic product, that would be a roughly 0.8-percentage-point drag on growth. Harvard’s Chodorow-Reich applied an approach different from Luzzetti’s, but his result was similar.
The economic grief might be amplified by how companies respond. Chief executives notoriously fixate on their share price when making hiring and investment decisions. After the Nasdaq lost a third of its value in 2022, tech companies rushed to slash workers and corral spending.
With the Nasdaq down more than 10% from its high, the independent economist Phil Suttle worries that spooked executives could pull back from plans to spend an estimated $1 trillion on investment related to artificial intelligence in the years ahead.
“Stock prices were telling executives that for every $100 billion you put into AI, you add some multiple to your valuation,” Suttle said. That could now stall, killing new projects including data centers and power plants, he said.
Exactly how people react to greater wealth is a moving target. When families get an unexpected windfall, such as a stimulus check or a lottery prize, they quickly spend a sizable share, Chodorow-Reich said. They are more stingy about spending stock gains. On average, a $1 change in stock-market wealth affects a family’s spending by about 3 cents, Chodorow-Reich found in a 2021 study with two colleagues.
U.S. households owned more than $56 trillion of stock at the end of last year, directly or through products such as mutual funds, according to Fed data, so the cents add up.
The economists Sydney Ludvigson and Martin Lettau studied wealth effects in the early 2000s. They concluded that steady stock gains boost spending over time, but that people usually don’t overreact to short-term fluctuations in the market.
Once in a while, a big move in stocks proves persistent and does change the course of consumer spending, Ludvigson said in an interview. The challenge for economists, she said, is that you can’t know which rallies or routs will be lasting until they are in the past.