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The Trickle-Down Effect: Decreased Spending Among the Wealthy Warns of an Economic Downturn

Five to six months ago, high-end real estate was thriving; homes in wealthier neighborhoods often sold before the signs had a chance to be put up, and bidding wars were commonplace. Multiple interest rate cuts in an economy that has been bullish for almost a decade have made people willing to pay top-dollar for new homes.

Now, houses in those same price ranges have been sitting for three or four months without an offer. Real estate is one of many sectors that face declines in the next financial quarter as the wealthy slow down on spending and transition more of their assets to cash.

One way to observe the difference in spending based on wealth is by comparing budget stores to their pricier counterparts. While TJX Companies (NYSE:TJX), the owner of discount retailers such as TJ Maxx and Marshall's, continues posting revenue and net income increases, Nordstrom's (NYSE:JWN) earnings have declined three quarters in a row. Barney's, which caters to the 1%, filed for chapter 11 bankruptcy this past August. After facing skyrocketing New York rent prices and decreased revenue, it took $75 million in new financing from Hilco Global and the Gordon Brothers Group for the company to secure its eventual recovery.

In addition to declines in luxury retail and real estate sales, jewelry, art and classic car markets have also suffered. In August, Pebble Beach's car auctions saw less than half of the cars offered for $1 million or more sold.

Meanwhile, Walmart (NYSE:WMT) stock prices and revenues are soaring in light of increased customer traffic. Major intrinsic value indicators such as Graham number and earnings power value suggest that the stock is overvalued. This is likely due in part to the fact that Walmart has yet to make significant enough price raises to offset the cost of trade war tariffs. Approximately 80% of products sold at Walmart are produced in China, so price increases and declines in net income for the famously cheap store are inevitable.


In terms of savings, the wealthiest 10% of the U.S. population has, on average, nearly doubled its savings on bank records over the past two years. So far, this effect has not yet been replicated among middle earners, but if the rich are spending less, it means less money is flowing through the economy; according to recent data from Moody's analytics, the top 10% of earners account for approximately 50% of total consumer spending. If this continues, it will lead to higher unemployment as reductions in cash flows force companies to cut costs. In the steps leading up to economic recession, this is the point at which the middle class begins converting more of their assets to cash as they mortgage houses, sell stocks and adopt a "security first" mentality.

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This article first appeared on GuruFocus.