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LAST WEEK THE government released its monthly employment figures for February. The results weren’t great. Payrolls declined, and unemployment ticked up. These numbers square with other downbeat data, including a recent uptick in bankruptcy filings.
Another worry: Oil prices have been rising, a result of the conflict in the Middle East. That’s a concern because it could lead to a reacceleration of inflation. It could also dampen consumer spending because higher gas prices act like a tax on consumers, leaving them with less to spend elsewhere.
For these reasons, commentators have started to talk about the possibility of stagflation—a combination of stagnant growth and higher prices. But is that where things are headed? To answer that question, it’s worth taking a closer look at two current economic trends.
The first is what’s been referred to as the K-shaped economy. To understand this idea, imagine a chart plotting the relative standing over time of those with higher incomes and those with lower incomes. Owing to a rising stock market, the shape of the chart for those with higher incomes extends up and to the right.
Folks with lower incomes, on the other hand, haven’t benefited as much from rising markets, and they’ve been more affected by higher inflation. So for this group, unfortunately, the shape of the chart is down and to the right.
Put the charts together and they form a K. But how will the two legs ultimately affect the economy and the market?
At first glance, this K-shaped divide would appear decidedly negative. That’s because lower-income consumers tend to spend a greater proportion of their incomes, so if they’re not doing as well, that can have more of an economic impact.
That’s the most obvious conclusion we might draw about a K-shaped economy. But in that kind of economic situation, that likely wouldn’t be the end of the story. Downbeat consumer spending, especially in combination with higher unemployment, would likely lead the Federal Reserve to continue its current round of rate cuts. That, in turn, would help consumers by making everything from mortgages to auto loans to credit card payments less expensive. All things being equal, it would also help the investment markets, owing to the math behind stock valuations.
The bottom line: This K-shaped dynamic doesn’t seem great, and probably isn’t great from a societal perspective, but the ultimate financial impact—and the timing of that impact—isn’t certain.
The second big economic trend today is the boom in artificial intelligence. That includes the infrastructure build-out, which has been enormous, as well as its productivity impact for users, which is still to be determined.
For now, all of the AI-related spending has been positive for the market and for the economy. But what will the ultimate impact be? On that question, there’s a lot more debate.
According to one view, AI will meaningfully boost productivity, by giving everyone what amounts to a highly productive assistant, or team of assistants. But there’s no consensus on this. Others believe that AI will replace large numbers of workers and cause widespread unemployment.
Which way will things go? This question is harder than it appears. Not only would we need to determine the net effect of AI. We’d also need to determine how those effects net out against all the other economic factors out there, including the K-shaped situation.
To choose just one example, tighter immigration controls could lead to higher wages, which could lead to inflation and maybe pressure on corporate profits. The number of factors is almost innumerable.
The bottom line: When markets wobble, the standard advice is to avoid overreacting. The reason for that is straightforward: because we can look back at history and see that we’ve managed to get through all past crises, and that the market has always recovered and gone higher.
But there’s another reason to avoid reacting too strongly or worrying too much. Where things ultimately go in the economy will always depend on the complicated interplay among all of the factors out there, from AI to the K-shaped economy to the war in the Middle East, and everything else, including things we aren’t even currently thinking about.
Investors, in other words, should be careful to not focus too narrowly on any one news item because, at any given time, it’s always going to be just one of many factors, and it’s very difficult to know how those factors will all net out, and when.
Adam M. Grossman is the founder of Mayport, a fixed-fee wealth management firm. Sign up for Adam’s Daily Ideas email, follow him on X @AdamMGrossman and check out his earlier articles.
History shows that most economic news have low correlation to what markets do in the next 1-4-12 weeks and why I hardly pay attention to them in regards to my portfolio.
On the other hand, I listen to every word the Fed chair says.
Economists forecasts over the years have been notoriously wrong.
Excellent article Adam. Stay the course, be patient, invest constantly. History says diversify and all will be well. The key is feed that IRA, every month. Word to the wise, many of us spend more in retirement not less.
All will work out.
I try to tell my sons to ‘do the right things when you are young, so you can do the right things when you are old’. Teaching money skills, helps folk be on the upward side of the ‘K’ IF they practice the information in their daily lives.
Thanks, Adam. Your closing paragraph sums up a great guiding perspective on the information we see and hear. Another thing to keep in mind is that if our information comes through the news, it’s been through the filter of an editor that made a decision about what to report and how to tell it.