Why a K-Shaped US Economy Is Raising Red Flags

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1:55Bloomberg Audio Studios. Podcasts, radio, news. If you squint at enough data about the U.S. economy right now, on income and spending and consumer confidence, there's a shape that starts to emerge. A letter. The letter K. A K-shaped economy is the result of a bifurcation in consumer confidence. Economist Peter Atwater is responsible for popularizing the idea of a K-shaped economy in 2020 during the global COVID pandemic. We should have hoped for a V-shaped recovery coming out of COVID where all ships rose together. Even a U-shaped recovery where there's a delay in the recovery, but ultimately it all rises together.

2:49But we didn't get a V. We didn't get a U. We didn't even get an L where things stayed bad for everyone. Instead, we got a K. So if you think about the letter K, it has a vertical line, obviously, and then two lines kind of diverging from the center of that vertical line. That's Bloomberg reporter Katerina Sariva. And the divergence she and Peter are talking about is a split in the paths of Americans at the top and bottom of the U.S. economy, with the fortunes of those at the top rising and those at the bottom getting worse. That's how the economy looked during the recovery from COVID. And it's how it looks again now.

3:31Today, fast forward to 2025, we're again talking about the K-shape because we are seeing kind of a return to that. We're seeing consumer spending really slow down for folks at the lower ends of the income spectrum, while rich folks are doing really well. And this time around, the two sides of that K are getting even farther apart. I'm Sarah Holder, and this is The Big Take from Bloomberg News. Today on the show, a tale of two economies. Why the gap between America's wealthiest and everyone else is widening. How it's showing up in company earnings reports. And what the K-shape means for the country's overall financial health.

4:24Economist Peter Atwater studies confidence and how it impacts consumers' decision-making. That's what originally drove him to recognize this K-shaped pattern. Early on in COVID, I saw as white-collar workers, their confidence immediately popped when they could work from home. On the other hand, blue-collar workers, factory workers, hospital workers, their confidence kept deteriorating. And so based on that divergence in confidence, I expected that the economy would follow. And Bloomberg's Katerina Sariva says it did follow. You had one group of people that were kind of in the upper echelons of the economy.

5:09So think like high-income earners, people with a lot of wealth. And those people were really doing well. The stock market was rising a lot already by the end of 2020. So people with wealth and people with jobs where they could work from home, for example, were doing really well. Now, the other half of the economy really wasn't. We still had like 11 million people unemployed at the end of 2020. That employment rate was above 6 percent. So for anyone who didn't have stocks, for example, maybe didn't own a home, things were not going great. Eventually, the government rolled out stimulus programs, lockdowns lifted, and companies started rehiring workers again.

5:52And that especially benefited the lower income folks because those were the people that had the most impact from the pandemic layoffs. So when you had companies trying to hire them again for a lot of these service industry jobs that had to shutter in the pandemic, you saw big wage gains. That has changed now. And in fact, it has reversed. The largest wage increases right now are for the highest income earners. Those high earners are also the people who tend to be making the most from the stock market. It's been just surging this year, so that obviously gives people confidence. There's research showing that each additional dollar of stock market wealth raises consumption by about 5 to 15 cents.

6:36And then not just the stock market. You know, you also have to look at wealth that's been created through homeownership. Again, something that disproportionately impacts wealthier people. And home prices have just increased so much over the past five years. That also helps people feel like they can spend more. Would you say that there's a capital K-shaped economy and then there's other lower K-shaped economies sort of playing out in other sectors like the housing market? Yeah, absolutely. We're really in a moment where it's becoming a really popular metaphor, I think. And it's being used across a variety of industries.

7:15So yeah, you can look at home buying where things are going really well for that upper part of the market because, again, folks are able to sell their homes and are able to have more wealth through the stock market so they can go buy a bigger home and not as much at the lower edges. I've heard it talked about, for example, if you're looking at how airlines are performing right now. So you look at the legacy carriers, like the big American Airlines Delta, they're doing really well and they're reporting that high end consumers, business travelers, for example, are spending. People are flying internationally, even if maybe not as much domestically.

7:54Right. So they're still seeing a lot of revenue from that. And then some of the smaller, like the low cost carriers, in some cases, like Spirit filing for bankruptcy, really not doing well. So it's an interesting dynamic that I think is playing out in a lot of different areas. You can see a similar trend in the food and hospitality industries, too. So you have some of these fast, casual places that are a bit more expensive, right? Like not the cheapest option out there, really not doing well. And then restaurant chains like McDonald's reporting that they're doing OK because they're getting a lot of these consumers that would be going to somewhere like Chipotle or Sweetgreen, for example, now kind of trading down to something like a McDonald's.

8:40You're also definitely hearing corporations talk about how their luxury consumers are really supporting their growth. Hearing this from the hotel chains, also hearing this from Ethan Allen, the furniture company that on the higher, higher end, they're still seeing a robust consumption there. And then that's supporting kind of the rest of their business. Businesses have found a way to cater to this divergence. Economist Peter Atwater again. Meanwhile, for those at the bottom, it's becoming a monthly, if not now, weekly exercise in juggling their finances. The Atlanta Fed has reported that some shoppers are shifting to liquid or powder laundry detergent instead of using pre-portioned pots so they can ration it out in smaller amounts.

9:29The grocery chain Kroger has found that lower - and middle-income shoppers are using more coupons and buying cheaper brands. People are trying to find ways to spend less. But the thing about a K-shaped economy is that even as the top and bottom are getting further apart, looking at the big picture can be misleading. Because when it comes to overall spending or overall growth, the economy looks like it's doing okay. We had stronger economic growth this year than most people thought we would. We have a pretty low unemployment rate still, right, like 4.3 percent. Things still look really good. It's just when you look under the hood, you realize that it's really being driven by a small number of people.

10:14This is important because the U.S. economy, we're a consumer economy. Two-thirds of economic activity in the U.S. is driven by the consumer. So when you start to concentrate that in an increasingly smaller number of people, it just means you have a more fragile system. In the early 90s, the top 10 % of earners accounted for about 35 % of the country's consumer spending. Today, they account for nearly 50%. And as the economy gets more top-heavy, it also becomes more fragile. What are the consequences? That's after the break.

10:54Today's show is brought to you by Vanguard. To all the financial advisors listening, let's talk bonds for a minute. Capturing value and fixed income is not easy. Bond markets are massive, murky, and let's be real, lots of firms throw a couple flashy funds your way and call it a day. But not Vanguard. At Vanguard, institutional quality isn't a tagline. It's a commitment to your clients. We're talking top-grade products across the board of over 80 bond funds, actively managed by a 200-person global squad of sector specialists, analysts, and traders. These folks live and breathe fixed income. So if you're looking to give your clients consistent results year in and year out, go see the record for yourself at Vanguard.com slash audio.

11:36That's Vanguard.com slash audio. All investing and subject to risk, Vanguard Marketing Corporation Distributor. I'm Barry Ritholtz, inviting you to join me for the Masters in Business podcast. Every week, we bring you fascinating conversations with the people who shape markets, investing, and business. CEOs, fund managers, billionaires, Nobel laureates, traders, analysts, economists, everybody that affects what's going on in the market, whether you own stocks, bonds, real estate commodities, crypto, you really need to hear these conversations. Sometimes it's behaviorists like Dick Thaler or Bob Schiller.

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12:49We've talked a lot about how the current economy is bifurcating, splitting, with the wealthy and everyone else on separate tracks, moving away from each other. The letter K. But economist Peter Atwater has another image to consider. A Jenga tower. I feel like the blocks in the Jenga tower, particularly at the very foundation, are being pulled away. At the top, so much is happening financially. And that would be okay if there was some level of robustness at the bottom, that if the K really represented strength at the top and the bottom. But what we have now is all of this oversized activity at the very top.

13:40Meanwhile, below it is becoming more and more fragile. In October, Fed Chair Jerome Powell said that this bifurcated economy is something he's watching very, very carefully. And Peter's watching closely, too. He believes that if something causes the wealthiest consumers to pull back on spending, say a big decline in the stock market, it could send the Jenga blocks toppling. We think of these markets as being representative of strength. And as a researcher, what I know is that invincible markets are incredibly fragile. And as confidence falls, scrutiny will intensify. One area that Peter thinks is especially vulnerable to scrutiny right now?

14:31AI. I think what it would take to topple is a relatively small event that challenges the confidence in AI. Individuals will challenge the benefits of all of this AI abstraction and demand immediate tangible results that it does not appear that it can yet deliver. So what would it take to bolster the Jenga Tower's foundations and to start narrowing the diverging parts of the K? It's no easy task. The government shutdown has put new immediate strains on lower-income Americans, with SNAP benefits on hold. And longer-term fixes haven't found much political momentum, at least at the federal level. Things like, you know, reforming the tax code, looking at things like the capital gains tax, which really is very low in this country, right?

15:31Looking at things like the payroll tax, estate tax, corporate tax rates, right? There's a lot of ways that you could change tax law to make it more progressive, I think economists would argue. I don't know right now how widespread of support there is for doing things like that at the federal level. Right. We just had a massive tax reform package go through that in some ways was kind of the opposite of what we're talking about. That was perhaps more helpful to higher income and corporations. Is a K-shaped economy just a euphemism for an unequal economy? Is the K just measuring inequality? Yeah, absolutely.

16:15We talked to some economists who noted that inequality, it's not new for the U.S. economy, right? We've had widening inequality for decades here. But widening inequality, when it gets to levels like what we're seeing right now, tends to not be good for an economy. Because what it can mean is that you can actually have slower growth, and it can even lead to things like social unrest. It's not just inequality in terms of an economic sense. This is inequality in multiple dimensions at once. Because for those at the bottom, they have scarcity in education, in healthcare, in childcare, in job opportunity.

17:03they have what I call stacked vulnerability, where the economic piece is just one more thing. And at the same time, those at the top have overabundance in everything. Power, money, influence. And so it's become very difficult for those at the bottom to ignore what's happening around them.

17:34This is The Big Take from Bloomberg News. I'm Sarah Holder. To get more from The Big Take and unlimited access to all of Bloomberg.com, subscribe today at Bloomberg.com slash podcast offer. If you like this episode, make sure to follow and review The Big Take wherever you listen to podcasts. It helps people find the show. Thanks for listening. We'll be back tomorrow.

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