10/18/2011 01:15 pm ET Updated Dec 18, 2011

Stock Market Declines Weaken Spending, Economic Recovery

In an economy already beset by deep troubles in housing and elevated joblessness, the stock market is now working as yet another source of anxiety that an anemic economic recovery could give way to another recession, in the view of many economists.

The U.S. stock market has fallen about 10 percent since its peak in late April, with many analysts attributing the losses to growing concerns about the sovereign debt crisis in Europe, the debt ceiling debate in Congress this past summer and grim U.S. economic data. As a result, many consumers have been spending less. Since consumer spending accounts for 70 percent of the U.S. economy, and more than half of Americans invest in stocks, some economists said that the American economy is unlikely to recover as long as stock prices and consumer spending continue to decline.

"If consumers are not spending, this economy is going nowhere," said Bernard Baumohl, chief global economist at the Economic Outlook Group.

Investors in stocks in the S&P 500 have lost a total of $1.49 trillion since the U.S. stock market's peak in late April, according to Standard & Poor's. Though the markets have recovered somewhat in recent sessions, they have remained in negative territory since late April, and confidence is in short supply.

Some economists who analyze consumer spending estimate that consumers spend three to five cents less for every dollar lost in the stock market. As stock market investors' wealth has plunged, American consumer spending has fallen 12 percent since July, according to Gallup, and consumer expectations of economic growth have plummeted 29 percent since May, according to Reuters and the University of Michigan.

Stock market declines have hit those Americans nearing or in retirement particularly hard, and as a result some of the elderly are now spending only on necessities. Judy Larkin, 80, a retired therapist living in Brooklyn, said she has cut back on buying food and taking public transportation because the value of her retirement account has fallen.

Bonnie Egan, 67, a freelance editor in New York, said that since the value of her retirement account has "gone down and down," she feels the stock market is no longer a good investment.

"I don't go out to eat. I don't go to the movies. I cook my own food. I'm not buying any clothes," Egan said. "I'm just buying exactly what I need."

The U.S. economy is in danger of entering a cycle in which less consumer spending and a falling stock market reinforce each other, said Beth Ann Bovino, deputy chief economist at S&P.

"It could become a self-fulfilling cycle if people watch this news, get scared, don’t spend, then you can see more alarming economic data, which causes markets to further fall," Bovino said.

The negative psychological impact of stock market declines may weaken the economic recovery for some time, as consumers feel less wealthy and cut back on spending as a result, economists said. The anxiety has even lowered spending by people who do not invest in the stock market, since they can see that the economy is not healthy, said Gregory Daco, principal U.S. economist at IHS Global Insight.

A range of negative economic factors have hurt consumer confidence. Americans are $7.7 trillion less wealthy than they were at the onset of the recession, according to CNN Money. They have lost some $7 billion in home equity alone as housing prices have fallen 32 percent since their peak in 2006, according to the Federal Reserve Bank of New York and S&P/Case-Shiller Home Price Indices, respectively.

As Americans have seen their net worth decline, they are also unlikely to see much of an increase in annual income. Some worry about keeping their jobs as unemployment stays elevated at 9.1 percent. Meanwhile, the wages of the employed have remained largely stagnant, denying workers the leeway to spend more.

Since many households have already been hurt by job loss or declining home values, Americans have become more sensitive to declines in the stock market, said Karen Dynan, an economist at the Brookings Institution.

Dynan said that declines in the stock market are "making people feel like the future is full of uncertainty, that they're going to need to save more, they're going to need some precautionary savings because who knows what the future holds."

The stock market's recovery of lost ground after the financial crisis was a key factor in the increase in consumer spending during late 2009 and 2010, according to Sal Guatieri, senior economist at BMO Capital Markets. But recent declines in the stock market and their negative impact on consumer spending have helped drag down the economic recovery, he said.

"People are spending on needs, not desires," said Chris Christopher, senior principal economist at IHS Global Insight. "People are poorer, and prices are higher .... If you have a lot of people unemployed or insecure about their jobs, they’re going to be extremely uncomfortable in spending money."

Americans are spending less because as their investments decline in value, they have less money to spend over the long term, said MIT economist James Poterba. He added that volatility in the stock market has negatively impacted consumers' expectations of future earnings.

Baumohl of the Economic Outlook Group said that stock market declines have "a very, very powerful impact" on people's sense of wealth and resulting spending habits. He said that since the net worth of all income groups has declined, consumer spending has remained "very, very anemic."

Baumohl said, "For most people, there is absolutely no distinction between a recession and what we are experiencing now."