U.S. Households' Financial Well Being Is at Risk

Are you better off financially than you were ten years ago? We live in a time of falling house prices, volatile stock prices, all-time high oil prices, rising unemployment rates, rising inflation, low savings rates, modestly increasing incomes, increasing health care costs and high levels of consumer debt. The result is that many U.S. households are experiencing a reduced standard of living while others are doing fine.

To quantify how U.S. households are doing financially, I (RAH) have constructed a new index called the buypside.com Financial Wellness Index, which combines six macro economic indicators (links to data sources in blue):

Stock market prices - S&P 500 monthly closes
Median income - All U.S. Households
Housing prices - S&P/Case-Shiller® Home Price Indices and HUD
Crude oil prices - Crude Oil Price Summary (EIA) and InflationData.com
Consumer credit - Federal Reserve
Health care costs - National Health Care Expenditures
Unemployment rate - Bureau of Labor Statistics

Essentially, the index is a broad measure of the nation's household balance sheet where stock prices, housing prices and median income describe assets and consumer credit (debt), oil prices, health care costs and unemployment act as liabilities.

Whenever stock prices, housing prices and incomes rise, household are generally better off financially; when they fall people are worse off. And when oil prices rise, consumer credit increases, health care costs rise and unemployment climbs, households are generally worse off. The index summarizes this tug of war between the competing factors that vie for peoples' money and ultimately affect their wealth and well being.

The index, computed each month, is the sum of the cumulative month-to-month changes (inflation adjusted) of the six economic indicators; each indicator is given the same weight. The index is sensitive to changes in stock, housing and oil prices; rising stock and housing prices pull up the index, but rising oil prices drag it down. In addition, long-term increasing consumer credit, a drag on the index, tends to pull it down. And the historical trend of increasing median household incomes tend to pull up and support the index. Increases in the unemployment rate pull down the index.

The chart of the monthly values of the index from January 1970 - March 2008 shows the ups and downs of the index. In general, the index tracks macro events including economic expansions and recessions.

The chart shows five periods of declining financial well being; three are associated with economic recessions (1973-1974, 1980-1982 and 1990-1991). The fourth decline occurred after the stock bubble burst in 2000 and was followed by a trend of flat index readings. And the fifth decline, which is happening now, is due to falling house prices, volatile stock prices with a negative bias and rising oil prices.

Since reaching a peak in 1999 the index has been on a general decline suggesting that the financial well being of many U.S. households has been gradually declining. And it appears likely that the index could continue to falter, at least to the level reached during the severe recession of 1980-1982.

Related Articles:

Get Set for a Rocky Stock Market in 2008
Inflation-Adjusted S&P 500 Price Pattern Signals Prolonged Downside
Stock Market Delivers Meager Gains to Investors
Stock Market Returns Are Likely to Decline for Buy-and-Hold Investors
Stock Market Returns Are Likely to Decline for Buy-and-Hold Investors - Part II

Posted April 3, 2008.