Bonds are NOT the biggest worry for the US equity market. The biggest worry is consumer spending power. Consumer spending rose at a 4.9% annual rate in December, but hourly wages rose at about half that rate, or 2.5% year-over-year. In order to spend faster than the increase in wages, consumers reduced their savings rate. US households are now saving just 2.4% of their disposable income, barely above the record low registered just before the 2008 financial crash.

As the chart shows, the value of household assets soared by 10% the year before the crash (red line, left-hand scale), in the last phase of the housing bubble of 1998-2007. We observe from the chart that asset prices jumped and the savings rate fell sharply just before the 2000-2001 recession as well. Capital gains, to be sure, represent money in the pockets of households, same as savings. But the capital gains of the late 1990s came disproportionately from the dot.com bubble and the capital gains of the mid-2000s came disproportionately from the housing bubble.

The capital gains of the last several years depend to an unknown extent on extremely low interest rates manipulated by central banks in the aftermath of the financial crisis. Interest rates are likely to rise very gradually because central banks (understandably) are cautious about rocking the boat. But a modest fall in equity prices combined with a jump in gasoline and home heating oil prices could prompt consumers to retrench. They cannot maintain their present rate of spending at the expense of savings, particularly if the stock market and the housing market are not generating capital gains.

Wage growth is low mainly because job creation has been concentrated in low-wage service industries. Manufacturing now is such a small percentage of total employment that even a fast rate of growth from a very low base won’t move the needle in terms of overall wages. If oil prices move above US$80 a barrel, the US consumer will feel squeezed. GDP growth is largely driven by consumer spending, and is vulnerable to a pullback. That’s not inevitable by any means, but it is a small black cloud on the horizon that bears careful watching.