Wealth managers are debating the best direction to go in what is being described as a "K-shaped economy."
A “K-shaped economy” describes a split economic recovery where one segment of the population flourishes (like the upward stroke of the “k”) while another fails (like the downward one). The winners in the current economy are the unyielding spenders on the upper end, especially those who own financial assets in their burgeoning 401ks.
On the flip side, inflation and stagnant wages have severely harmed the fortunes of many lower and middle-class American families.
Mike Serio, chief investment officer for Trilogy Financial, is in the K-shaped economy camp. He adds the massive investment in AI, which will create new jobs requiring specialized skills, but will also make some lower-skilled jobs disappear, as another factor in the troubles affecting lower income households.
“As we have seen in markets past, there may be a reckoning and eventually, all this capital will have to pay off. In the early 2000s, we saw this with the dot-com stocks, where we did get some great, innovative companies, but there were many failures, which added to the bear market of the era,” Serio said.
Austin Graff, chief investment officer at 49 Financial, believes the dichotomy in prosperity between high and low earners has been prevalent since inflation became an issue in 2022, and has recently picked up steam with stubborn inflation outpacing the labor market.
“Those that have significant assets are advantaged and those with less significant asset bases can be hurt by inflation as the growth in cost of living outpaces income growth,” Graff said.
From the investor perspective, Graff says it’s important to own companies that serve those with high incomes and significant assets, or companies that offer a compelling value proposition. More specifically, he recommends looking for companies that will capture more market share through a value proposition as more consumers trade down.
“A simple example is consumers trading down from department stores or Target to Walmart or Dollar General. The discounters who offer compelling values are likely to pick up more share,” Graff said.
More broadly, he suggests looking for companies that can benefit from key secular themes with less focus on consumer spending, such as industrial electrification, reshoring of manufacturing, aging population, or technological innovation.
In terms of investments to avoid in a K-shaped economy, Graff recommends steering clear of companies that are "stuck in the middle," or those that are accustomed to charging high prices for products and services but with minimal differentiation. Companies that have recently fallen into this category are generic retailers, branded food companies, legacy media.
“These companies have historically charged high prices for products and services that have historically been geared towards lower and middle-income consumers. When these consumers are struggling to make ends meet, they will be more sensitive to the value they receive,” Graff said.
Trilogy’s Serio, meanwhile, is cautious about small caps and would not be passive as “private equity has changed the market.”
“More private equity capital has been raised than ever before, and this is reflected in the public markets, where many of the better opportunities remain private,” Serio said.
And while international markets have been strong year to date, Serio said they are still not superior to the US equities despite America’s split economy.
“Demographics and selected growth-killing government policies in these areas are dismal, and there is no apparent reason that these will change anytime soon,” Serio said.
Finally, Brian Peardon, private wealth advisor at BridgePort Financial Solutions, says sectors that rely heavily on middle- and lower-income consumers—such as mass-market retail, autos, budget airlines, small-caps, and lower-end hospitality—are the most vulnerable in a k-shaped economy.
“These areas face slowing demand, rising delinquencies, layoffs, and reduced spending as affordability pressures hit the bottom 60% of households. Because of this pullback, cyclical and lower-priced consumer sectors tend to struggle while the rest of the economy’s gains concentrate at the top,” Peardon said.
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