“The stock market is not the economy” is a common refrain.

The thinking goes that while losses in the stock market may hurt Wall Street investors, Main Street is the real backbone of the economy.

While that may be true, stocks are an important psychological lever and there is a threshold for losses, beyond which the pain in the market can spill over and hurt consumer spending.

That’s the thinking that underpins the concept of the “wealth effect,” or the idea that rising and falling asset values have a material impact on consumers’ spending habits.

In other words, when the stock market rises and consumers see swelling investment portfolios, it instills confidence to keep spending even if their actual incomes haven’t moved. On the flip side of that, losses in the stock market can curtail spending as people watch their wealth on paper decline.

America’s self-fulfilling economy

“I think this is the most important thing for people to understand that’s unique about the US economy, is what we think we manifest,” Sherry Paul of Morgan Stanley Private Wealth Management told CNBC this week. “We’re a 70% consumptive GDP society so how we think and feel actually has a material impact on how we spend.”

With the S&P 500 down nearly 10% from its peak and having wiped out $5 trillion in value, it’s no surprise that recent economic data has shown consumers starting to pull back on their spending habits.

Retail sales dropped 1.2% in January, representing the biggest monthly drop since July 2021, and sales in February rose by 0.2%, much less than the 0.7% economists’ forecast.

While downbeat consumer sentiment and weakening data can be tied to the uncertainty coming out of the Trump administration, it is also likely affected by the plunging stock market.

Company outlooks have not been encouraging

Kristina Hooper, chief global market strategist at Invesco, said in a recent note that the latest commentary from companies, including Macy’s and Delta Air Lines, suggests a slowing economy, partly driven by wealthy Americans dialing back.

“Affluent consumers in the US are likely to be reducing spending at least partially because of the substantial stock market drop, which has historically impacted perceptions of net worth and negatively impacted consumer spending,” Hooper said.

This highlights the broader economic implications of wealth perceptions that are influenced by stock market dynamics.

Economist Mark Zandi of Moody’s highlighted the same dynamic in a conversation with BI last week, warning that absent a quick rebound in the stock market, consumer weakness would likely persist.

“The well-to-do are focused like a laser beam on their stock portfolios, and if the stock market shows a lot of red, they don’t feel good and at some point they’re going to pull back on their spending and that could be the fodder for a broad economic downturn,” Zandi said.

Stocks saw more red on Friday, with the Dow Jones Industrial Average plunging more than 700 points and the S&P 500 declining by 2%.

According to market experts who spoke with BI, there’s no clear answer as to how low the stock market has to go for there to be a negative impact on consumer spending.

Instead, the real question is how long the stock market decline will last.

“It’s not so much a daily move or necessarily a percentage move in the market, but it’s whether or not whoever is being impacted thinks that it’s permanent so to speak,” Thomas Martin, senior portfolio manager at Globalt Investments, said.

Martin argued that the middle class could see the biggest pullback in spending habits amid a bear market.

“I think at the very top, it probably doesn’t influence people that much because they’ve got enough money that they’re cushioned anyway, and at the lower end, they don’t have wealth, so it’s those middle quintiles that are the ones that are affected the most,” Martin explained.

To be sure, the stock market is not the only factor that can influence consumers’ perceptions. Jamie Cox, managing partner for Harris Financial Group, said property values also play a big role.

Cox argued that surging real estate prices over the past 15 years have “anchored” the wealth effect for most American homeowners. Perhaps most importantly, as long as Americans can hold onto their jobs, they are likely to remain resilient in their spending.

“A stable job and rising home equity provide a more direct effect on consumption that the stock market, which, ironically is basically flat to slightly positive for most investors who have and have had diversified portfolios,” Cox said.