US consumers: a wise crowd

There's been some good news for the US economy lately. No, not just the obvious. I mean the Fed's flow of funds data.
These showed that  the ratio of consumer spending to households' net worth fell in Q2, and is now far below its long-term average.
The reason why this is good was described by Uncle Milt in the permanent income hypothesis. The idea here is that consumers try to smooth out their spending over time. So if they see bad times coming, they'll rein in their spending in anticipation, so they won't have to cut it much in the subsequent downturn.
This theory implies that a low ratio of spending to wealth is a sign that consumers foresee hard times, and  that such a ratio will lead to falling wealth but not necessarily falling spending.
And guess what? There's some truth in this. My chart shows that the consumption-wealth ratio has been a great predictor (correlation = 0.69) of moves in net worth in the following two years. When spending's high relative to wealth, wealth subsequently grows - because consumers spent some of the good times in advance. And when spending's low relative to wealth, wealth subsequently falls.
This doesn't mean there's no danger to spending. But it does suggest it won't fall very much, simply because households have been implicitly bracing themselves for lower house prices for a while.
This might be good news for the macroeconomy, but it's bad news for the managerialist class in two senses:
1. A low consumption-wealth ratio predicts falling share prices (though some of this has of course happened since the end of Q2.) The evidence here was put in this paper by Martin Lettau and Sydney Ludvigson.
2. This implies that ordinary Americans, in aggregate, are wiser than fund managers and the forecasting class, as they've (partly) seen falling house and share prices coming.  Which raises the question: could it be that the smart money is to be found on Main Street, not Wall Street?

Comments

[Bonapart O Cunasa]

But another explanation for a falling consumption-wealth ratio could be rising inequality. If more of the wealth is owned by the rich, but the rich consume less of each extra dollar, then this is what you'd observe - with no implications for the foresight of American households.

[kinglear]

Various commentators believe that the Man on the Clapham Omnibus is actually the bellweather of the economy. The drop in consumption is quite simply when he feels worried ( put a bit aside for a rainy day) and when the tills are ringing it's because he feels good about the future. The wealth effect is because - as every good fund manager knows - check what the little man is doing en masse - and then do the exact opposite.

[Laurent GUERBY]

I'm curious as how net worth is estimated, does the Fed knows the exact price of every house and parcel of land in real time?