Can the Bulls Survive a “Let Them Eat Cake” Economy?

There has been increasing concern about the K-shaped economy. Fed Chair Powell specifically addressed this issue at the last post-FOMC press conference:

To start with the layoffs, you’re right, you see a significant number of companies either announcing that they are not going to be doing much hiring, or actually doing layoffs, and much of the time they’re talking about AI and what it can do. So, we’re watching that very carefully…On the K-shaped economy thing, I would say the same thing, or similar thing. We are —- if you listen to the earnings calls or the reports of big, public, consumer-facing companies, many, many of them are saying that there’s a bifurcated economy there and that consumers at the lower end are struggling and buying less and shifting to lower cost products, but that at the top, people are spending at the higher income and wealth, and they’re — so much, much anecdotal data on that.

Investors are seeing a bifurcation in consumer sentiment. Sentiment of households with incomes over $100,000 are at or near a cycle high, while sentiment for households making below $100,000 are plunging in 2025.
 

 

This is setting up to be a “let them eat cake” economy. While the stock market isn’t the economy, can the bull market survive such a bifurcation if most U.S. consumers are struggling?
 

 

Charting the K

It’s no surprise that the top 20% of income distribution owns most of the wealth. Inequality can be beneficial but problematic at extremes. Inequality is the engine that drives the American Dream. Too much inequality, however, can lead to regulatory capture and political instability.
 

 

At the high end of the income distribution, soaring asset prices have contributed to improvements in consumer sentiment and spending. Mark Zandi of Moody’s Analytics estimated that the “so-called wealth effect is responsible for nearly half a percentage point of real GDP growth over the past year, accounting for one-fourth of the economy’s overall growth.”
 

 

On the other hand, income insecurity is growing.at the other end of the income scale. The BoA reported that “Lower-income households have the highest share and largest increase of households living paycheck to paycheck”.

 

At the same time, wage growth for the lowest income quintile has seen their wage growth decelerate after running “hot” post-COVID, while the wage growth of top quintile earners has been steady.

 

In addition, tax and trade policy has exacerbated the effects of the K-shaped economy. Estimates from Yale’s Budget Lab show that the combined effects of the OBBB Act and tariffs has worsened the finances of the low-end American while improving those at the high end.
 

 

Technical analysts worry about narrow stock market leadership. Should equity investors worry about narrow economic leadership? Can the top 10–20% of the U.S. population sustain economic growth and dynamism and what does that mean for stock prices?
 

 

The Wealth Effect

At the top end of the income scale the wealth effect is very real. Investors saw that during the Dot-Com Bubble. You feel richer, you spend more.

Today, investors are all piling into technology and AI-related issues. Indeed, the NASDAQ 100 has been on a tear since the GFC and handily beaten the S&P 500 during that period (red dotted line). Moreover, the NASDAQ 100 recently staged a relative breakout and its normalized momentum indicator (black line) is only in the middle of its 12-month range and not overbought.
 

 

Should investors be concerned? San Francisco Fed President Mary Daly recently discussed the pressures on inflation and growth today compared to the 1970s, when inflation ran out of control. The high inflation era of the late 1970s was characterized by low productivity growth (light blue line).
 

 

By contrast, the Dot-Com Bubble era was characterized by high productivity growth. She concluded that today’s “asset valuations reflect higher productivity expectations, whether AI ends up to be transformative or not”.
 

 

Minneapolis Fed President Neel Kaskari addressed the dual mandate tension between elevated inflation readings and a weak labour market with an alternative explanation of how the “labour market and stock market could both be right”:

A third explanation that I have focused on is the possibility that the neutral rate of interest, R*, is higher, at least in the near-term, and that capital is being reallocated away from labor-intensive industries to less labor-intensive industries. We have seen a remarkable investment boom in technology—building data centers for AI, for example. While it takes a lot of people to build a new data center, it takes relatively few to operate one. The markets fund those investments via a higher R*, which makes building new apartment buildings, for example, less economically attractive, and instead capital flows to higher return investments in Silicon Valley. Thus the labor market and the stock market could both be right: Technology is driving rapid growth of industries that don’t require as much labor, resulting in a booming stock market and sluggish hiring environment. In addition, while we’ve focused extensively on the price effects of tariffs on imported goods, we shouldn’t forget the other side of that coin is that capital from abroad would be more expensive, nudging R* up. In this view, monetary policy might not be particularly tight, and even if the FOMC embarks on a number of policy cuts, long-term interest rates might not fall much in response. The housing market might not actually experience much relief from rate cuts.

 

 

A Constructive Outlook

While it’s unclear whether the AI-driven productivity boom narrative postulated by Daly and Kashkari will ultimately prevail, that seems to be current narrative in asset markets.

Investors all know about the race by hyperscalers to invest and build capacity, but momentum is building beyond the headlines. Reuters reported that NVIDIA supplier Foxconn recently offered an upbeat outlook on AI-related demand.

One of the fallouts from the Dot-Com Bubble bust was the emergence of excess internet capacity. That doesn’t seem to be the problem today with AI capacity. Bloomberg reported that supply chain issues is still a problem with AI capacity. Already built data centres are sitting empty because they can’t get access to power.

 On a related point, Morgan Stanley published a research report concluding that the “memory supercycle” is far from its ultimate peak. While past cycles peaked when price-sensitive customers reduced orders when memory prices rose, the current customer base dominated by data centres is largely price-insensitive and more focused on GPU capacity and capability than memory prices.

 

To be sure, some cracks are appearing in asset markets. Even as technology stocks go from strength to strength, the credit default swap (CDS) premiums of tech companies are rising relative to banks, though readings aren’t excessively high by historical standards.

 

An analysis of high yield (junk bond) funding costs relative to past NASDAQ 100 bulls shows that credit market anxiety is relatively low. Froth is appearing in the NASDAQ 100, but readings aren’t bubbly compared to past history.
 

 

In addition, the quarterly Senior Loan Officer Survey shows no signs of tightening credit conditions.
 

 

I interpret these conditions as signs of strong fundamental momentum. If AI is in a bubble, which it probably is, it’s far from its peak. The AI industry currently suffers from a shortage of capacity. Major tops don’t look like this, and these conditions should be intermediate-term bullish for AI-related stocks.
 

Lastly, concerns have been rising about weakness in the employment market in the absence of official data because of the government shutdown. The market was rattled by the publication of two privately sourced data on employment, ADP and Challenge job cuts, which showed weakness. The market implied odds of a December rate cut rose as a consequence.

In the absence of official government October employment data, New Deal democrat, who monitors coincidental, short and long leading indicators of the U.S. economy for signs of recession, analyzed the public sources of ADP, ISM and regional reports. He concluded:

There were roughly no job gains at all, +/- about 40,000. Meanwhile wages continued to grow at a relatively fast pace, in accord with the official data from earlier this year. And the unemployment rate was steady to slightly higher compared with earlier.

These conditions should nudge Fed officials towards a December rate cut, though hawkish speeches from several voting regional Fed Presidents (Collins, Musalem and Goolsbee, plus Schmid who dissented against an October cut) who pushed back against the notion.
 

For the last word, I offer a comparison of the conventional indicator of risk appetite, as measured by the ratio of the equal-weighted consumer discretionary to consumer staple stocks, compared to my “let them eat cake” factor, as measured by the ratio of the performance of luxury goods maker LVMH and the Dollar Store. The conventional equity risk appetite indicator (dotted green line) has closely tracked the S&P 500 and shows no significant divergences. By contrast, the “let them eat cake” factor (red line) roughly tracked the S&P 500 until “Liberation Day” and diverged significantly from the stock market since then. I interpret this to mean that “let them eat cake” concerns are less relevant to stock prices and worries about narrow economic leadership are overblown.
 

 

In conclusion, the economy is undergoing a K-shaped expansion. While the top-end consumer is doing well, the middle and bottom ends are struggling. I don’t believe inequality has grown to levels that this is a “let them eat cake” economy or stock market. Equity investors are still enjoying AI-related gains driven by the promise of productivity gains. While the employment market appears weak, there are also signs that the jobs market may be improving, which could lift the bottom of the K in 2026.