Is the K-shaped economy real?

0:06Pushkin. Markets and the US economy are brought to you today by the letter K. You may have heard people talking about this lately. Even central bankers are saying it's a thing. It's this idea that one group of people, no prizes here for guessing that's rich people, are holding up the economy. That's the pointy up bit of the K. While poorer people are scrimping and saving. That's the downward sloping bit. It cuts across to markets too. We have a small group of stocks in the US, unsurprisingly tech stocks, that are screaming higher. And the rest of the market is a bit meh. Now, markets love this sort of thing.

0:45We have V-shaped recoveries, L-shaped recessions, and now all the cool kids are on about the K-shaped economy. Today on the show, we're asking whether that actually makes sense or whether markets people are just really proud of how well they know the alphabet. This is Unhedged, the markets and finance podcast from the Financial Times. I'm Pushkin. I'm Katie Martin, a markets columnist at the FT in London, back from having lots of fun and slightly too much booze at Kilkenomics in Ireland. And I'm joined down the line from New York City by His Excellency, the very Reverend Robert Armstrong off of the Unhedged newsletter.

1:27Katie, I thought K-shaped stood for Katie-shaped. I don't know what that would mean exactly. It's quite short with curly hair. now rob before we get on to k-shaped our inbox has been bulging this week has it not a lot of correspondence about two things yes firstly contrary to the letter we got last week saying that i was too mean to you we received lots and lots of emails from people saying i'm not too mean to you and if i am mean to you i should carry on being mean to you then there are two Two explanations. One was meanness is how the British express affection, as everyone knows. And the other was that I deserve mean treatment because I'm an interrupter.

2:10And I've fact checked both of these claims and I think they are true. Yes. If it's any consolation, I can tell you from a weekend in Ireland that there's nothing that people in Ireland love doing more than being mean to the Brits. So it's the circle of life. Yeah, it goes around, comes around. It goes round. The second point I've received a lot of correspondence on was making your own dishwasher tablets. Yes. What does he make them out of? Well, so I asked him, but first of all, so... We can edit this out later. I just have to hear. He doesn't listen to this podcast, so I thought I would get away with it.

2:46But it turns out his financial advisor does listen to this podcast and texted him saying, why are you making your own dishwasher tablets? So I have to admit that I brought it up here and I got a massive eye roll from Mr. Martin. Anyway, for those asking, the recipe is one of those stupid American cup measurements of bicarbonate of soda, one of citric acid powder, both of which are easy to buy online, and one tablespoon of washing up. Of nitroglycerin. do not buy nitroglycerin online or anywhere else washing up liquid so you mix it up you put it in an ice cube tray and then it will set but and um i i hate to admit it but they do actually work so should we talk about a serious topic now other than can we get back to the economy of america suppose so tell me mr armstrong about this k-shaped thing and why everyone is going on about I think context is really important here because with these narratives that take on a life of their own, a lot of things tend to get confused in the enthusiasm for a simple and appealing story.

4:07So let's start with some context. The main thing is that in terms of wealth, and I'm contrasting wealth to income here, the United States is massively unequal. So if you look, the Fed studies this stuff very carefully and has something called the distributional counts that lay out the facts. But basically, 90, I don't know, 6 % of the wealth, say, somewhere between 96 and 98 % of the wealth is owned by the people on the top half of the wealth spectrum. So basically, half the people have all the money and the other half have almost nothing. That is the picture in America. Now, what's important to remember, though, is that that is not new news.

4:50That is not something that just happened recently. So we have all these corporate executives right now. I'm thinking of Procter & Gamble, Coca-Cola, Chipotle. All of these companies have come out and said we're seeing a big divergence in behavior between well-to-do consumers and not-so-well-to-do consumers. One spending a lot or continuing to spend at a good pace while the poor consumer spends less is contracting. Now, you can't just put that down to vast wealth inequality in America because that was true all along. Something has to have changed here. Let me tell you something that has changed.

5:29So a few days ago, we got the consumer sentiment report from the University of Michigan. and it said U.S. consumers see a 23 % chance of losing their job over the next five years and that is in the 99th percentile historically going back to when they started gathering this data in 1997. So people have an unusually high level of insecurity about their job and yet stock markets are just like, well hey, party time. So it's like something is wrong with this picture. Yeah. And part of the reason that I think the K-shaped economy narrative has taken on so much momentum is that we are in an objectively confusing economy where, although the unemployment rate is low, which is important to, you know, we're close to the level they call full employment.

6:23About as many people are employed as can be employed in a modern economy right now, about. But nobody's getting hired. And there's not a lot of new job creation. And yet, GDP is growing very well. So how do you reconcile those two facts? And there's a lot of other incongruous facts like this that need reconciling. And the K-shaped economy helps pull together these incongruous facts. That being said, I think something is going on here about people's assessment of their prospects. My hypothesis would be that something has happened to change people's attitude about the future because the stuff in the present hasn't changed that much.

7:07The unemployment level, the growth of the economy, et cetera, et cetera. So what's going on? so one thing to bear in mind there is as you say like you know job openings have been falling pretty fast while the economy seems to have been growing and while markets seem to have been going up and the charts going around sort of showing these two things diverging and saying oh look it's okay it's okay the problem is that like some of that weirdness that's going on in the jobs market is like the long tail of covid you know when like people like hired like mad companies hired like mad because it was really hard to hire people and in the US but you had you know less immigration at the time so it was hard to find people so there were loads of ads out there and then you know you're sort of seeing that unwind and and you do see that in other economies as well so there's an effort to kind of pin some of this case-shaped phenomenon onto chat GPT and say look it looks like AI is eating away at job openings, but I'm not sure a lot of that stacks up actually, because what happened with this sort of, you know, upsy-downsy sort of phenomenon in the jobs market predates ChatGPT.

8:19So to me, I don't know, maybe a lot of it is just people trying to make sense of why markets are so kind of, you know, fizzy and excited and happy about the world when there are just so many data points that tell you you shouldn't be? Maybe it's just that. I think you're on the right track in the sense that explaining what is happening here, on the assumption that what companies are telling us is true about the behavior of lower-income consumers generally. And I think, by the way, you don't have to take every single word a company says as gospel about this stuff. Yes. You know, that's that. And we can talk about that in a second.

9:01But taking what they say is true. You kind of have to do psychology. It can't all be in the numbers like you're thinking about how consumers think about the future. So the numbers aren't going to tell you the whole story, but I will tell you some numbers that connect to the story, which is that everything we know about the kind of labor market and wages and so forth tells us that somewhere 22, 2023, workers really had the upper hand. They were very much in demand. You could switch jobs and get paid more. So right after the kind of trauma of the pandemic, which we all remember, there was this moment where it really looked like the sun was coming out in an extraordinary way for working people.

9:53It's not that things are so bad now, but that sense that the kind of deal between labor and management, as it were, had changed has faded. Yeah. And we're kind of back to the back to the old days. And that may be weighing on people's psychology, like, oh, I look really good for a second there. But now we're back to the same old stuff. And that could be part of it. Thing is, for markets generally, you know, psychology, mycology. So there are people who are calling BS on this whole K-shaped economy thing. They include, but are not limited to, Dario Perkins from T.S. Lombard, friend of the show, friend of your newsletter.

10:36He said, everyone in financial media is talking about wealth effects as a reason for the K-shaped economy. Fact check. True. They are. They are talking about that. The more the U.S. stock market rises, the wealthier people feel and the more they spend. At this point, this whole thesis is becoming a cliche, but not all cliches are true. His argument is there's no evidence of this and the savings rate among wealthy people is flat. So, you know, what wealth effects? Yes. And look, everybody knows that the very rich, when you give them more money, they just invest it like they're consuming as hard as they can always.

11:13Yeah. You know, as they say, their marginal propensity to consume is very low. That's part of the problem. And several people have made this point, too. If the issue was that all the money was going to the wealthy right now, then growth would be worse. Because when you give very rich people more money, they don't tend to spend it. They don't tend to spend more of it. In other words, they don't spend more than they were spending already. So I think there has been, you're quite right, there's been exaggerated claims on the consumption side about how much of consumption is now down to rich people.

11:57And the idea that that has radically changed, that now, like, suddenly nobody buys disc detergent anymore, but, like, for diamonds and cocaine, things are going brilliantly. I just think that's not true, and I don't think there's any evidence for it. Can you make cocaine at home? I don't know. Listeners, please don't tell us. So also calling, like, low-key calling BS on this is Don White from Absolute Strategy Research, another friend of the show. And he's saying that this idea that consumption is so concentrated among the very, very wealthy is just like a little bit off and that there's not much evidence and that he doesn't have a good sense that it's like changing particularly over time.

12:41So I do kind of wonder where this K-shaped thing kind of really got its claws into the narrative. I think it's partly around, if I remember rightly, Someone asked Jay Powell, chair of the Federal Reserve, the U.S. Central Bank, about it not so long ago. And he didn't sort of bat it away. You know, he accepted it as a premise to take seriously. So his kind of, you know, acknowledgement or semi-acknowledgement that this is a thing has just kind of let it run away with itself. And now everything's just like K-shaped, K-shaped. I think we need to make a distinction between two forms of the K-shaped economy thesis.

13:16One is a claim about the rich and the claim that all the spending that is going on in America, all the consuming, all the economic growth is down to rich people getting richer and spending more of their wealth. I think we have very good reason to believe that this version of the thesis is false. Then there's a second form of the K-shaped thesis that poor consumers are behaving differently now because they have a different view of their prospects than they might have had a year or two ago. And I think we have some reason to believe that that version of it is true, which brings us back to when Coca-Cola, Procter & Gamble, Chipotle, dollar store CEO, whoever, one of these people says our lower income consumer is struggling and sort of working paycheck to paycheck.

14:09You know, how – I mean, as one correspondent wrote into me after I wrote about this and said, how do they know who their rich and their poor customers are? It's a good question. Do they ask them at the door? But, you know, that's a story that a corporation can tell about why they didn't have a great quarter that is not self-incriminating. Yes. In other words, it's a lot easier story to tell then. Well, actually, we've been kind of letting things slip generally around here and we had a bad quarter and we screwed up in various ways. It's it's more it's more palatable to say, well, it's a harsh world out there and our customers are under pressure.

14:55I'm not saying these guys are making this story up. All I'm saying is you can see why an executive might lean into the K-shaped narrative rather than leaning into our product is not very popular. People are not listening to this podcast because of the K-shaped economy. That's what you're saying. Yeah, exactly. And there are companies that are reporting pretty well. Yeah. Do you know what I mean? And so it's like not every company is complaining about this. I mean, so. So there's other factors playing in as well. I guess where I land on this is like job insecurity and poor confidence among lower income households and families like matters and is something to take seriously.

15:39But again, it's not clear to me that this is new. Like America is pretty famous for this. All kind of rich economies are pretty famous for this. So ultimately, who cares? As humans, we care that these people are having a tough time. You know, life's tough on a low income with high prices. But ultimately, what difference does that make to markets or to monetary policy? Because again, like people who set interest rates for a living have always been incredibly mindful of income disparities and wealth inequality. So what? Okay. So for companies, if it is true that people on lower incomes are being more cautious about their consumption because the future doesn't look as bright to them.

16:20That's going to matter to certain companies, right? So you have to think about the companies who serve those populations. And, you know, that's a kind of stock by stock decision you have to make. The question of what a central banker should do in the face of this is very interesting because their mandate makes them ignore certain pieces of information. Like ultimately, what they're supposed to look at is employment and the rate of inflation. Right. And if the rate of inflation is above target, like it is now, and the rate of unemployment is still reasonably low, then if they were to say, look, poor people are suffering, we have to change our policy package here, they would be sort of exceeding their mandate.

17:12And if there's one thing MAGA don't like, it's the Fed exceeding its mandate. In a sense, no matter how hard the Fed tries not to be political, right, just stay out of politics, our job is monetary policy, we set interest rates, like you kind of can't help it. Like the outcomes of what monetary policy does have political implications. So it's always political whether it wants to be or not. I mean, who would be a central banker? Not me. I don't understand politics very well. And I try not to go too far from markets land into politics land. But I will say that the stuff we've been talking about on this show, of course, is an incredibly live political issue.

17:54Yeah. Both sides of the American political spectrum care about tremendously. So remember, you can look at Trump's policy set as an effort to speak to and help the people in that lower half of the wealth spectrum. Tariffs, in theory, are supposed to help those people get, in theory, and we can have all the discussion, are supposed to help those people get paid more. That's supposed to bring high paying jobs back to America to help those people. affordability is an issue for them right that he's very i mean we you have trump talking about sending out checks again this week right and at the same time the democrats who won several local and national elections last week they're talking about affordability too so the stuff we're talking to today whether or not it's relevant to markets and how you can be damn sure it's relevant to every politician.

18:52And so the fiscal policies will respond to this stuff, even if monetary policy does not. Listeners, I don't know if you agree, but what I'm getting here is Rob Armstrong is going to run for president, ladies and gentlemen. You heard it here first. Yes, he's running. It's going to be every household in America will be able to afford store bought dishwasher tablets under the Armstrong administration. No more making your own dishwasher tablets. What a beautiful policy platform that is. Listeners, we'll be back in just a couple of minutes for Rob to flesh out more of his policy platform with Long Shorts.

19:41Okie doke, it is time for Long Short, that part of the show where we go long, a thing we love, or short, a thing we hate. Rob, what you got? I am long passive investing. Are you? And this is a very standard thing to be long among finance nerds like myself, but I'm going to reiterate it because of this great story by our colleague Costas Morsellas. Elliott Management, which is a big hedge fund, had to explain in their letter recently why their performance, their returns since 1994 have now fallen behind the returns of the S &P 500. And it's a story as old as time that a big fancy hedge fund over time turns out not to outperform the index.

20:30But what is striking about this particular story is that Elliott Management is really good at this stuff. They are a very well-run fund, activist investment fund. And even they, over a multi-year period, struggle to keep up with the old big cap U.S. index. So once again, yay for just owning that tracker fund. My only count's point to that would be that a tracker fund that tracks the U.S. market is effectively an active fund that is leaning into big tech stocks. So there's kind of no difference. they're just okay fine fine anyway rain on my parade will you have katie i will you can take your vengeance when you're president although i could be like your chief of staff or something anyway yeah i am short the story by our colleague laith al-khalaf who wrote lloyd's banking groups like a retail banking group in the uk analyzed data from the personal bank accounts of more than 30 ,000 employees to assess their financial resilience as part of pain negotiations.

21:36And I'm like, am I the only person who thinks that's a bit icky? That just sounds like an unfair way to negotiate with your employees to me. Like, you don't tell me what my salary is going to be on the basis of how rich you think I am. You pay me because I'm doing work that's worth something to you. I mean, I just find it odd that like, it's okay to aggregate and look at employees data in that way. Yeah, that story just makes me angry. I'm with you in shorting. Yeah, I can't quite articulate why I don't like it, but I don't like it. I find it weird. On that note, we will wrap up there. Listeners, if you have adventures with dishwasher tablets or indeed with anything else we've mentioned in the show today, please get in touch.

22:20Unhedged at ft.com. We will be right back in your actual ears on Tuesday. Unhedged is produced by Jake Harper and edited by Brian Erstad. Our executive producer is Jacob Goldstein. Topher Forhears is the FT's acting co-head of audio. Special thanks to Laura Clark, Alistair Mackey, Greta Cohn and Natalie Sadler. FT premium subscribers can get the Unhedged newsletter for free. A 30-day free trial is available to everyone else. Just go to ft.com slash unhedged offer. I'm Katie Martin. Thanks for listening.

23:02We'll be right back.