Market Commentary

• Financial reporters are stating that we are living in a “K-shaped economy” without really defining what that means.
• The concept tries to illustrate the bifurcated consumer landscape that exists in the current economic cycle

The financial world is full of jargon that might seem confusing to many investors. Lately, almost every time you tune in to your favorite financial TV network, reporters are stating that we are living in a “K-shaped economy” without ever really giving a good explanation of exactly what that is. This week we want to briefly explain what is behind that frequently used phrase and review where we currently stand on guidance on stocks and bonds.

Let’s try to visualize this K-shaped economy. First, on one hand, think about high-income consumers who have a large amount of disposable discretionary income. Next, consider that consumers on the lower end of the income scale have much less disposable discretionary income. Those consumers spend a far higher percentage of their income on basics, like food and housing, compared to consumers at the high end of the income scale. The financial media has been using this K-shaped term to describe what many economists would call a wealth gap or an indication of wealth inequality.

Overall economic growth has been good in the U.S., but not all consumers are feeling the benefits. Those on the lower end of the income scale, as represented by the downward sloping portion of the K-shape, have not seen their income keep pace with the level of inflation over the last five years. That means their buying power has diminished, as the overall price level of goods and services has risen noticeably.

But consumers at the higher end of the income scale have benefitted from the economy, as the value of stocks, homes, and many other real assets have risen. As far as the K-shape is concerned, their consumer experience is represented by the upsloping portion of the “K”. Their discretionary income continues to be strong and funds the purchases of cars, houses, vacations, and meals at restaurants.

Today, low-income households are being squeezed by high prices, softening wage growth, and weak job growth, but we think there may be a reversal as the trends converge for a better economy in 2026. We’re already seeing small businesses planning to hire more workers, and small businesses accounted for 70% of the new jobs created since 2019. That should help improve the bottom leg of the “K”. The same trends should also help drive efficiencies that we think will increase profit margins, earnings, and equity prices in 2026. That should help the upper arm of the “K” and create the investment opportunities we expect in technology-related trends, such as artificial intelligence (AI) data centers.

We believe the tailwinds from tax cuts, deregulation, and lower interest rates are mutually reinforcing. Business tax cuts for capital spending should promote business expansion and modernization. We want to retain exposure to the AI theme and carry full market-weight allocations to the Technology and Communication Services sectors. We also believe that an improved economy and the overall AI theme will benefit the Financials (most favorable) sector along with the favorable-rated Industrials and Utilities sectors.

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