The wealth effect that’s driving our K-shaped economy… have we slipped into a new economic model?… why earnings are more important than ever… how to invest in light of this delicate system
What if the economy wasn’t being lifted by paychecks anymore – but instead, by brokerage statements?
On Sunday, The Wall Street Journal ran a piece highlighting the “haves” versus “have-nots” split in our economy that co-Digest writer Luis Hernandez and I regularly spotlight.
The article noted that the “wealth effect” is behind so much of today’s spending from Americans with assets.
From the WSJ:
Investors’ rosy feelings about having a lot more money—at least on paper—are powering spending on restaurant meals, business-class airline tickets, home improvement and more, keeping the broader economy humming…
The phenomenon of people spending more when assets they own go up in value is known as the “wealth effect.”
Meanwhile, in the lower spoke of the “K” of this K-shaped economy, Americans without assets face high retail prices and paychecks that aren’t keeping up with inflation. The result is that sentiment has sunk to near its lowest reading on record, according to the latest University of Michigan survey.
Is the wealth effect changing the traditional relationship between the economy, the investment markets, and the labor force?
What if it’s no longer the economy that’s making people rich, but instead, “feeling rich” is critical for a robust economy?
If there’s anything to this idea, there are significant implications for this bull market, our social cohesion, and your portfolio.
Why the wealth effect is today’s new growth engine
Historically, we’ve understood the market as a general mirror of the economy.
When businesses hired more workers, paid better wages, and saw rising productivity, those fundamentals translated into stronger corporate earnings, which in turn pushed stocks higher.
In that world, a strong labor market was the foundation of everything.
But as we’ve highlighted over the last few months, AI is breaking the link between employees and profits. We’re entering a new era where a company can grow earnings without growing payroll.
Yesterday’s model: Healthy job market → higher wages → more spending → stronger earnings → rising stock prices.
Today’s “wealth effect” model: Rising stock prices → wealth effect spending → resilient GDP → “healthy” economy…
From a “yesterday’s model” perspective, today’s job market isn’t all that healthy. While we’re not seeing massive layoffs yet, they’re rising fast. At best, we have what Federal Reserve Chairman Jerome Powell calls a “low hire, low fire” market.
Meanwhile, if you do have a job, wages aren’t keeping pace with inflation, and Americans’ wallets are hurting.
Yesterday, a new Bank of America report found that 29% of lower-income households are living paycheck to paycheck. That’s up from 28.6% last year and 27.1% in 2023. Bank of America blamed the increase on slowing wage growth.
Turning to the “wealth effect” model, evidence suggests that Upper-K consumers are feeling stronger than ever, exhibiting a greater influence on our economy than in recent decades.
Here’s Oxford Economics, a global economic advisory firm, from last month:
Since the onset of the COVID-19 pandemic, significant gains in net wealth have driven almost a third of the increase in consumer spending.
Despite an unfavorable backdrop, consumer spending will grow at a decent pace this year, largely thanks to the stock market rally that started in April…
Wealth effects have strengthened over the past 15 years, with stocks becoming a bigger driver of consumption than housing.
Mark Zandi, chief economist for Moody’s Analytics, reports that the top 10% of wealthiest Americans accounted for 49% of consumer spending at the end of Q2.
Think about that: just one out of 10 Americans wields the same economic power as the other nine combined.
This K-shaped economy helps explain one of the puzzles of our time – why median Americans feel squeezed while the overall economic data looks healthy.
The first issue with this new model – a closed-system economy
If the economy increasingly runs on spending by asset owners, then Americans without meaningful assets become less integral to the growth story. And that creates a new risk –exclusion.
To what extent are we slipping toward what you might call a “closed-system economy?” One where the loop circulates among the Upper-K cohort – and largely bypasses half the country who don’t own stocks or significant assets?
When prosperity bypasses giant swaths of the population, political and social consequences often follow. History tells us that if the situation becomes dire enough, we can expect rising disenfranchisement, frustration, and eventually, pushback.
The election of democratic socialist Zohran Mamdani to mayor in New York City last week (which we profiled in this Digest) may be a tiny signal of that broader shift.
The next big problem with this new model – chicken or egg?
If spending is primarily dependent on asset wealth, and asset wealth depends on market performance, we’ve entered what I’ll call a Reflexive Economy – a system that feeds on its own success – maybe even if that success hasn’t materialized…or can slip away.
In my October 10th Digest, I highlighted an example of this “betting on the come” – the partnership between Advanced Micro Devices (AMD) and OpenAI (disclosure: I own AMD).
On the surface, it was a blockbuster: OpenAI committed to buying tens of billions of dollars’ worth of AMD’s AI-focused chips. AMD gets massive new revenue, OpenAI gets diversified computing power – win-win.
But as our macro investing expert Eric Fry of Fry’s Investment Report and his lead analyst Tom Yeung explained, the deal’s structure raises eyebrows.
Instead of writing AMD a $60 billion IOU for the chips, OpenAI persuaded AMD to issue 160 million stock warrants – essentially options to buy AMD shares – for a penny each. Those warrants become valuable only if AMD’s stock price rises to certain key levels.
So, notice the reflexivity:
- OpenAI’s ability to pay for AMD’s chips depends, in part, on AMD’s stock price rising enough to make those warrants valuable.
- AMD’s stock price rising depends, in part, on optimism about the OpenAI deal and the future revenues from OpenAI.
And what’s the common ingredient for both AMD and OpenAI?
Confidence.
Confidence that OpenAI will pay… confidence that AMD’s stock will rise.
In the same way that the wealth effect is based on confidence that unrealized wealth won’t disappear (so let’s keep spending!), this kind of circular deal is based on confidence that both parties will live up to their end of the bargain.
Neither is guaranteed.
And this means one thing…
Today, tangible earnings are more important than ever
Earlier this week in his Innovation Investor Daily Notes, our hypergrowth expert Luke Lango explained why nervous tech investors should be watching earnings, not pricy valuations:
If we look back at the Dot Com Boom…we can see that rich valuations didn’t pop the bubble.
The S&P 500 traded >20X forward earnings throughout essentially all of 1998, 1999, and 2000 – yet…it wasn’t until EPS estimates started to fall, in the second-half of 2000, that the Dot Com Boom turned into the Dot Com Bust…
Big picture readthrough: If you’re looking for a top, follow earnings, not valuations.
Luke’s point is critical.
Today’s lofty valuations reflect the “wealth effect” powering this Reflexive Economy. And earnings are the bridge connecting these inflated assets to real-world spending.
Now, yes, valuations are high. But today’s earnings are real and strong – and that’s keeping today’s new wealth effect model at least partially grounded in reality. At a minimum, it means the inflation bubble doesn’t have to pop.
But when earnings fall, watch out.
Here’s how that loop looks:
- Wall Street will have to reprice lower earnings into its PE ratios, causing stock prices to fall.
- Wealthy Americans who have been propping up the economy due to the wealth effect will see lower portfolio values and spend less.
- Reduced spending hits earnings again, and nails sentiment (the PE ratio multiple) even harder as some Upper-K Americans realize their “wealth” was only on paper.
- Lower-income Americans can’t come to the rescue – they’ve been shut out of this closed system for a while, growing increasingly disillusioned.
- Earnings and sentiment continue spiraling downward as the wealth effect goes in reverse.
Bottom line: Luke is right – valuations aren’t the trigger we need to be watching. They can stretch. But when lower earnings result in kneecapped confidence, that’s when the fragility of today’s new model will become apparent.
The good news is…
We’re nearing the end of Q3 earnings season, and we’ve seen strong earnings numbers. As importantly, forecasts remain solid.
Here’s FactSet, the go-to earnings data analytics group used by the pros:
- For Q4 2025, analysts are projecting earnings growth of 7.5% and revenue growth of 7.1%.
- For Q1 2026, analysts are projecting earnings growth of 11.8% and revenue growth of 7.7%.
- For Q2 2026, analysts are projecting earnings growth of 12.7% and revenue growth of 6.8%.
If these figures play out, the Wall Street party will continue. But recognize the reality…
If Lower-K Americans play less of a role in today’s economy… and if the wealth effect is playing an outsized role… then the moment earnings roll over, the feedback loop unwinds – painfully.
That’s why investors today can’t afford to treat this as theory. This feedback loop runs straight through your portfolio.
So, what’s the action step?
We play smarter offense and defense.
For defense, let’s return to Eric. He’s urging investors to take profits on potentially overextended names, such as Amazon, Tesla, and even Nvidia (disclosure: I own AMZN). They’re great companies, but not necessarily great investments at today’s prices.
He also just told subscribers to lock in a 106.7% gain on AMD after analyzing its complicated OpenAI deal – Eric is adamant about owning only certain AI plays today.
To help investors navigate what to sell – and where to reinvest profits – he recently released a “Sell This, Buy That” research package. It lays out which AI (and non-AI) plays still have the earnings strength to thrive in this Reflexive Economy.
Inside, he spotlights three under-the-radar stocks he believes are “Buys” – companies with the real cash flow and growth potential to protect and multiply your money as this late-stage bull evolves.
You can see all three tickers – free of charge – in Eric’s special broadcast.
For offense, look to veteran trader Jonathan Rose
A former professional trader who’s trained more than 100 pros, Jonathan now helps everyday investors trade the same setups used on Wall Street.
He focuses on short-term momentum and disciplined risk control, and his results speak for themselves. Here are just a handful of his recent trade returns and the hold periods:
- 209% in 13 days – LYFT
- 275% in 25 days – ETHA
- 700% in 15 days – MP
- 227% in 49 days – U
- 534% in 3 days – MP
On Tuesday, Jonathan – joined by Eric, Luke, and Louis Navellier – held his Profit Surge Event. They discussed today’s most lucrative investment trends and how they’re playing them.
While Eric, Luke and Louis tend to focus more on medium- or longer-term holds, Jonathan zeroes in on the short-term “surge points” that occur inside those same trends. Look again at the list above to get a sense for how quick these trades can be.
If you missed that discussion, you can watch a free replay right here.
Wrapping up
Are we in a new model today? One where prosperity flows less from paychecks and more from portfolios?
If so, we need to recognize that the wealth effect works in reverse, too, which makes this bull more fragile than we might want.
To be clear, we’re still riding it – but we’re increasingly watching earnings. If/when they go, we don’t want to be around for what comes next.
We’ll keep tracking this here in the Digest.
Have a good evening,
Jeff Remsburg
