Navigating the K-shaped economy

In this month’s commentary, our Chief Economic Adviser, Colin Warren, examines the divergence between affluent households and those that are financially strained in the US, and explores what this could mean for investors.

The term “K-shaped” economy gained prominence during the Covid pandemic as a shorthand for the starkly diverging fortunes of different groups and sectors - the two ‘arms’ of the ‘K’. On the upward ‘arm’ were white-collar workers able to continue working remotely and technology-focused sectors that benefited from accelerated digital adoption, while on the downward ‘arm’ were retail and hospitality workers who lost jobs as customer-facing businesses were hit hard by lockdowns and other social-distancing measures.

The notion of a K-shaped economy is once again making the headlines, as an apparently resilient US economy belies a widening divergence beneath the surface. Large swathes of consumers continue to struggle with lacklustre income growth, the rising cost of living and a more precarious labour market, while wealthier households have prospered from rising asset prices.

When it comes to household spending, there is growing evidence that US personal consumption is increasingly being driven by wealthier households. Research by Moody’s Analytics shows that the top 10% of earners accounted for 49.2% of total household expenditure in Q2 of this year (1). This represents the highest share since the data series began and is up from roughly one third in the early 1990s.

Wealth effects

Several factors help explain this trend. One obvious factor is the so-called wealth effect. Higher income households tend to own a larger share of financial assets and property, so when asset values rise, they feel richer and increase spending. The US housing market has been somewhat lacklustre recently, not least due to historically high mortgage rates. However, the US stock market, as measured by the S&P500, has risen by over 70% in the last three years, and is currently up around 15% year-to-date (2).

Wealthier households have disproportionately benefited from these gains. A study by the Federal Reserve Bank of St Louis concluded that as of the third quarter of 2024, the top 0.1% of US households held about 70% of their financial wealth in equities, compared with 15-20% for the bottom 50% of households (3).

In addition, recent wage data suggest that the pay of higher earners is growing at a faster pace than that of lower earners.  According to figures from the Federal Reserve Bank of Atlanta, annual wage growth for the top 25% of earners was 4.6% in August, compared with 3.6% for the bottom quartile (4).

The causes of this trend are not entirely clear. Artificial Intelligence (AI) and digital transformation is undoubtedly raising the pay for certain highly-skilled roles, and could be reducing bargaining power for some lower-skill workers. Another possibility is that tariffs are prompting companies in affected sectors to cut costs elsewhere, thereby constraining wage growth. Some observers have also suggested that heightened policy uncertainty - particularly around tariffs - has contributed to a softer labour market and a “no-hire, no-fire” dynamic, in which firms hesitate both to expand headcount and to shed workers. In such an environment, opportunities for lower-paid or younger workers to transition into higher-earning roles might have become more limited.

Tariff impact

It should also be remembered that the fiscal policy of the Trump administration has benefitted the very wealthy, while leaving most other income groups worse off. Analysis by the Yale Budget Lab shows that for all income groups apart from the top 10%, the combination of this year’s tariffs and the One Big Beautiful Bill Act (OBBBA) actually reduced post-tax-and-transfer incomes on average (5).

Indeed, there is broad agreement in the economics community that tariffs tend to hit lower income households harder than the well-off. This is because lower income households tend to spend more of their income on tradeable goods (e.g. food, clothing, household goods etc) which are subject to tariffs, rather than services (e.g. hospitality, leisure etc.) which are not. The Yale Budget Lab reckon that the 2025 tariffs hit the bottom 10% of earners around three times more than the top 10% (6).

With rising stock markets boosting the finances of wealthier households, and the high cost of living squeezing lower-income earners, it is hardly surprising that confidence among the former has held up better. The latest University of Michigan sentiment survey showed an 11% rise for households in the top stock-holding tercile (7), even as overall consumer sentiment slumped to the second lowest on record in November (8). 

Sectoral stress

The effects of the K-shaped economy are increasingly visible across corporate sectors. The market for motor vehicles provides an illustration of the stresses being experienced by consumer groups in the lower arm of the ‘K’. Data from Fitch Ratings show that the share of subprime borrowers at least 60 days behind on their car loans rose to 6.65% in October, the highest level on record (9). These mounting credit stresses were a contributing factor - alongside allegations of fraud - to the high-profile bankruptcy of Tricolor (a firm that sold vehicles and provided financing mainly to low-income Hispanic customers in the US Southwest) in September (10).

Examples of the K-shaped phenomenon can be seen in other industries. The Hotel operator Marriott International recently increased its 2025 profit forecast, as strong demand for its luxury brands offset soft demand for its budget offerings (11). Similar trends have been seen in other parts of the hospitality sector, including restaurants. McDonald’s, for example, recently cited a “two-tier economy,” noting strong spending from higher-income customers alongside cutbacks among lower-income diners (12). Procter and Gamble, Coca-Cola, and Delta Airlines have made similar announcements. 

Political fallout

The widening gap between affluent households and financially-stretched consumers is increasingly shaping the political landscape and influencing policy priorities. A recent example is the election of democratic socialist Zohran Mamdani as New York’s mayor, which was widely credited to his focus on affordability and his high-profile pledges to freeze rents, introduce free bus travel, and establish city-owned grocery stores. Although New York has long leaned progressive, the Republican Party has recently suffered several other key gubernatorial and mayoral election losses, where affordability was a key issue. There is a growing perception that policies centred solely on economic growth no longer resonate with the electorate if the benefits appear to accrue to only a small share of the population.

Sensing mounting discontent across large parts of the electorate, the Trump administration has begun to recalibrate its approach. After repeatedly insisting that US consumers would not bear the cost of tariffs, President Trump recently reversed course, signing an executive order that exempts a range of food products, in an effort to ease household grocery bills (13).

In addition, President Trump has proposed issuing US$2,000 cheques to Americans (excluding ‘high-income people’), funded by tariff revenues. However, the likelihood of such payments remains uncertain given the strained state of public finances and the need for congressional approval (14). Paradoxically, a stimulus of this magnitude could add to inflationary pressures, potentially worsening the cost-of-living pressures it seeks to alleviate. Higher inflation risks could, in turn, prompt the Federal Reserve to delay rate cuts, or even hike rates - while an unfunded fiscal transfer would raise questions over debt sustainability and potentially push US Treasury yields higher. Higher yields could, in turn, exert valuation pressure on equity markets.

Implications for investors

All of this suggests the K-shaped economy carries significant repercussions for investors. Given the current bifurcation across many markets, relying solely on headline indicators that signal economic resilience is unlikely to provide investors with sufficient insight into the underlying sectoral divergences that could impact investment performance. On current trends, companies with strong pricing power that are exposed to wealthy consumers appear well placed to outperform those that depend more on demand from more vulnerable, price-sensitive households.

However, there are also risks at the macro level. An increase in defaults in weaker consumer-linked sectors could spill over into broader credit tightening if lenders become more cautious. Moreover, an increasing reliance on equity-driven wealth effects to support household consumption could leave the economy more exposed to any stock market pull-back, a risk that is especially relevant given today’s elevated US large-cap valuations (15).

Investors should also be alert to possible policy responses aimed at addressing the growing discontent among financially-pressured households. Fiscal interventions designed to support household finances could inadvertently heighten inflation and debt-sustainability fears, potentially introducing additional volatility into fixed-income and equity markets.  Growing frustration over affordability could prompt a broader push for price controls, potentially squeezing profit margins in the industries affected. Over the longer term, a sustained leftward shift in voter sentiment could make the taxation of wealth more politically expedient.
 
All in all, the K-shaped economy presents both opportunities and challenges that neither investors nor policymakers can afford to ignore.

17^th November 2025