Is the K-shaped economy real?

Speaker 1 At PGM, expertise across public and private markets today helps build resilient portfolios tomorrow.

Speaker 1 With over $1.4 trillion in AUM, PGM has navigated over 30 market cycles with active investing and disciplined risk management. But it's not just about the numbers.

Speaker 1 Our combined global expertise and local insights give us the strategic perspectives we need to help you reach your long-term goals. PGM, our investments shape tomorrow today.

Speaker 1 Kushkin.

Speaker 2 Markets and the US economy are brought to you today by the letter K.

Speaker 2 You may have heard people talking about this lately. Even central bankers are saying it's a thing.

Speaker 2 It's this idea that one group of people, no prizes here for guessing that's rich people, are holding up the economy.

Speaker 2 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.

Speaker 2 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.

Speaker 2 Now markets love this sort of thing. We have V-shaped recoveries, L-shaped recessions and now all the cool kids are on about the K-shaped economy.

Speaker 2 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.

Speaker 2 This is Unhedged, the markets and finance podcast from the Financial Times. I'm Pushkin.

Speaker 2 I'm Katie Martin, a markets economist at the FT in London, back from having lots of fun and slightly too much booze at Kilconomics in Ireland.

Speaker 2 And I'm joined down the line from New York City by His Excellency, the very Reverend Robert Armstrong, off of the Unhedged newsletter.

Speaker 3 Katie, I thought K-shaped stood for Katie Shape to come. I don't know what that would mean exactly.

Speaker 2 Quite short with curly hair.

Speaker 2 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.

Speaker 2 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 that if I am mean to you, I should carry on being mean to you.

Speaker 3 And there are two explanations. One was meanness is how the British express affection, as everyone knows.

Speaker 3 And the other was that I deserve mean treatment because I'm an interrupter.

Speaker 3 And I've fact-checked both of these claims, and I think they are true. Yes.

Speaker 2 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

Speaker 2 the circle of life.

Speaker 3 Yeah, it goes around, comes around. It goes around.

Speaker 2 The second point I've received a lot of correspondence on was making your own dishwasher tablets.

Speaker 3 Yes. What does he make them out of?

Speaker 2 Well, so I asked him, but first of all, so he...

Speaker 3 We can edit this out later. I just have to hear.

Speaker 2 He doesn't listen to this podcast, so I thought I would get away with it. But turns out his financial advisor does listen to this podcast.

Speaker 2 and texted him saying, why are you making your own dishwasher tablets? So I had to admit that I brought it up here and I got a massive eye roll from Mr. Martin.

Speaker 2 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.

Speaker 3 Nitroglycerin.

Speaker 2 Do not buy nitroglycerin online or anywhere else. Washing up liquid.

Speaker 2 So you mix it up, you put it in an ice cube tray, and then it will set.

Speaker 2 And

Speaker 2 I hate to admit it, but they do actually work.

Speaker 3 So. Should we talk about a serious topic now?

Speaker 3 Can we get back to the economy of America?

Speaker 2 I suppose so. Tell me, Mr.
Armstrong, about this K-shaped thing and why everyone is going on about it.

Speaker 3 I think context is really important here because with these

Speaker 3 narratives that take on a life of their own,

Speaker 3 a lot of

Speaker 3 things tend to get confused in the enthusiasm for a simple and appealing story.

Speaker 3 So 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,

Speaker 3 the Fed studies this stuff very carefully and has something called the distributional counts that lay out the facts. But basically

Speaker 3 90,

Speaker 3 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.

Speaker 3 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.

Speaker 3 That 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.

Speaker 3 All of these companies have come out and said we're seeing a big divergence in behavior between

Speaker 3 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.

Speaker 3 Now, you can't just put that down to vast wealth inequality in America because that was true all along. Yes.
Something has to have changed.

Speaker 2 Let me tell you something that has changed.

Speaker 2 So a few days ago we got the consumer sentiment report from the University of Michigan and it said US 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.

Speaker 2 So people have an unusually high level of insecurity about their job and yet stock markets are just like, whoa, party time. So it's like something is wrong wrong with this picture.

Speaker 3 Yeah.

Speaker 3 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.

Speaker 3 You know, about as many people are employed as can be employed in a modern economy right now, about.

Speaker 3 But nobody's getting hired.

Speaker 3 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.

Speaker 3 And the K-shaped economy helps pull together these incongruous facts.

Speaker 3 That being said, I think...

Speaker 3 Something is going on here about people's assessment of their prospects.

Speaker 3 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.

Speaker 3 The unemployment level, the growth of the economy, et cetera, et cetera. So what's going on?

Speaker 2 Aaron Powell, Jr.: 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.

Speaker 2 It's okay. The problem is that, like,

Speaker 2 some of that weirdness that's going on in the jobs market is like the long tail of COVID.

Speaker 2 You know, when like people like hired like mad, companies hired like mad because it was really hard to hire people.

Speaker 2 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,

Speaker 2 and then you know, you're sort of seeing that unwind. And you do see that in other economies as well.

Speaker 2 So, there's an effort to kind of pin some of this K-shaped phenomenon onto chat GPT and say, look, it looks like AI

Speaker 2 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 chat GPT.

Speaker 2 So,

Speaker 2 to me, I don't know, maybe a lot of it is just people trying to

Speaker 2 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.

Speaker 3 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.

Speaker 3 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.

Speaker 3 But taking what they say is true,

Speaker 3 you kind of have to do psychology. It can't all be in the numbers.
Like you're thinking about

Speaker 3 how consumers think about the future.

Speaker 3 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 in 22, 2023,

Speaker 3 workers really had the upper hand. They were very much in demand.
You could switch jobs and get paid more.

Speaker 3 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.

Speaker 3 It'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.

Speaker 3 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 looked really good for a second there, but now we're back to the same old stuff.

Speaker 3 And that could be part of it.

Speaker 2 The thing is, for markets generally, you know, psychology, shmycology. So

Speaker 2 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.

Speaker 2 He 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 the fact that.

Speaker 2 The more the US stock market rises, the wealthier people feel and the more they spend. At this point, this whole thesis is becoming a cliché, but not all clichés are true.

Speaker 2 His argument is there's no evidence of this and the savings rate among wealthy people is is flat. So, you know, what wealth affects?

Speaker 3 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.

Speaker 2 Yeah.

Speaker 3 You know,

Speaker 2 I mean,

Speaker 3 they're, you know, as they say, their marginal propensity to consume is very low. That's part of the problem.
And I, I, and several people have made this point too. If the issue

Speaker 3 was that all the money was going to the wealthy right now, then growth would be worse.

Speaker 3 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.

Speaker 3 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.

Speaker 3 And 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.

Speaker 3 And I don't think there's any evidence for it.

Speaker 2 You know what I mean? Can you make cocaine at home? I don't know. Listeners, please don't tell us.

Speaker 2 So also calling like low-key, calling BS on this is Dom White from Absolute Strategy Research, another friend of the show.

Speaker 2 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 that and that he doesn't have a good sense that it's like changing particularly over time so i do kind of wonder where this k-shaped thing kind of really got its claws into into the narrative i think it's partly around if i remember rightly someone asked jay powell chair of the federal reserve u.s central bank about it not so long ago and and he didn't sort of bat it away you know he he accepted it as a premise to 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 one

Speaker 3 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.

Speaker 3 I think we have very good reason to believe that this version of the thesis is false.

Speaker 3 Then there's a second form of the K-shaped thesis that poorer consumers are behaving differently now because they have a different view of their prospects than they might have had a year or two ago.

Speaker 3 And I think we have some reason to believe that that version of it is true.

Speaker 3 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.

Speaker 3 You know, how,

Speaker 3 I mean, as

Speaker 3 one correspondent wrote into me after I wrote about this and said, how do they know who they're rich and they're poor customers? That's a question.

Speaker 2 Did they ask them at the door?

Speaker 3 But, you know, that's a story that a corporation can tell about why they didn't have a great quarter

Speaker 3 that is not self-incriminating. Yes.
In other words, it's a lot easier story to tell than, well, actually,

Speaker 3 we've been kind of letting things slip generally around here and we had a bad quarter and we screwed up in various ways.

Speaker 3 It's more palatable to say, well, it's a harsh world out there and our customers are under pressure.

Speaker 3 I'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.

Speaker 2 People are not listening to this podcast because of the K-shaped economy. That's what you're saying.

Speaker 2 Yeah, exactly.

Speaker 3 And there are companies that are reporting pretty well. Yeah.
Do you know what I mean? So it's like not every company is complaining about this.

Speaker 2 I mean, right.

Speaker 3 So there's other factors playing in as well.

Speaker 2 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.

Speaker 2 But 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?

Speaker 2 As humans, we care that these people are having a tough time. You know, life is tough on a low-income with high prices.
But ultimately, what difference does that make to markets or to monetary policy?

Speaker 2 Because again, like people who set interest rates for a living have always been incredibly mindful of income disparities and wealth inequality. So

Speaker 2 what?

Speaker 3 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, that's going to matter to certain companies.

Speaker 3 Right. So you have to think about the companies who serve those populations.
And that's a kind of stock-by-stock decision you have to to make. The question of

Speaker 3 what a central banker should do in the face of this is very interesting because their

Speaker 3 mandate makes them ignore certain pieces of information. Like ultimately, what they're supposed to look at is employment and the rate of inflation.

Speaker 3 Right. And if the rate of inflation is above target, like it is now,

Speaker 3 and the rate of unemployment is still reasonably low,

Speaker 3 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.

Speaker 2 And if there's one thing, Mag, I don't like, it's the Fed exceeding its mandate. Like, in a sense, no matter how hard the Fed tries not to be political, right? Just stay out of politics.

Speaker 2 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.

Speaker 2 So it's always political whether it wants to be or not. I mean, who would be a central banker? Not me.

Speaker 3 I don't understand politics very well, and I try not to go too far from markets land into politics land.

Speaker 3 But I will say that the stuff we've been talking about on this show, of course, is an incredibly live political issue that both sides of the American political spectrum care about tremendously.

Speaker 3 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.

Speaker 3 Tariffs, in theory, are supposed to help those people get, in theory, and we can have a whole discussion, are supposed to help those people get paid more.

Speaker 3 It's supposed to bring high-paying jobs back to America to help those people. Affordability is an issue for them, right?

Speaker 3 That he's very, I mean, you have Trump talking about sending out checks again this week, right?

Speaker 3 And at the same time, the Democrats who won several local and national elections last week, they're talking about affordability too.

Speaker 3 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.

Speaker 3 And so the fiscal policies will respond to this stuff, even if monetary policy does not.

Speaker 2 Listeners, I don't know if you agree, but what I'm getting here is Rob Armstrong's going to run for president, ladies and gentlemen. You heard it here first.

Speaker 2 Yes.

Speaker 3 He's running. There is going to be.

Speaker 3 Every household in America will be able to afford store-bought dishwasher tablets under the Armstrong administration. No more making your own dishwasher tablets.

Speaker 2 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.

Speaker 1 At PGM, expertise across public and private markets today helps build resilient portfolios tomorrow.

Speaker 1 With over $1.4 trillion in AUM, PGM has navigated over 30 market cycles with active investing and disciplined risk management. But it's not just about the numbers.

Speaker 1 Our combined global expertise and local insights give us the strategic perspectives we need to help you reach your long-term goals. PGM, our investments shape tomorrow, today.

Speaker 2 Hookie 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?

Speaker 3 I am long,

Speaker 3 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 Marcellus.

Speaker 3 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.

Speaker 3 And it's a story as old as time that a big fancy hedge fund over time turns out not to outperform the index.

Speaker 3 But 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.

Speaker 3 And even they, over a multi-year period, struggle to keep up with the old big cap US index. So once again, yay for just owning that tracker fund.

Speaker 2 My only counterpoint 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.

Speaker 3 They're just okay, fine, fine.

Speaker 2 Fine, fine.

Speaker 3 Anyway, rain on my parade. Will you have Katie?

Speaker 2 I will. You can take your vengeance when you're president.
Although I could be like your chief of staff or something. Anyway,

Speaker 2 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 pay negotiations.

Speaker 2 And I'm like, am I the only person who thinks that's a bit icky?

Speaker 3 Like, 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.

Speaker 3 You pay me because I'm doing work that's worth something to you.

Speaker 2 I mean,

Speaker 2 I just find it odd that it's okay to aggregate and look at employees' data in that in that way yeah that story just makes me angry i'm with you and 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 unhedged at ft.com we will be right back in your actual ears on tuesday

Speaker 2 unhedged is produced by Jake Harper and edited by Brian Erstadt. Our executive producer is Jacob Goldstein.
Topha Vorhez is the FT's acting co-head of audio.

Speaker 2 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.

Speaker 2 Just go to ft.com/slash unhedged offer. I'm Katie Martin.
Thanks for listening.