The term “K‑shaped economy” gained prominence as the U.S. emerged from the Covid pandemic. Rather than recovering evenly, the economy split into two distinct paths: one group experiencing strong gains, the other struggling to keep pace. Several years later, this divergence has become even clearer.

Consumers: A Split Recovery

Despite rapid growth in AI‑related capital spending, the U.S. economy is still fundamentally powered by consumer spending. Higher‑income households—who were more likely to keep their jobs during the pandemic—have also benefited from strong stock market performance, rising home equity, lower mortgage rates, and larger cash balances.

Importantly, these differences did not begin with the pandemic. Instead, they reflect an economy that has grown more sensitive to asset prices since the Global Financial Crisis. Recent consumer spending data consistently shows stronger growth from higher‑income households compared with lower‑income households, with the gap widening through 2025.

Corporations: AI Drives a New Divide

Since the launch of ChatGPT in late 2022, the K‑shaped pattern has become especially visible in the corporate sector. A small group of mega‑cap technology companies now dominates equity performance, earnings growth, and capital investment.

• The Magnificent 7 have accounted for 30–34% of S&P 500 market capitalization over the last two years (compared with under 20% during the 2022 bear market).
• Technology, media, and telecom stocks now represent over 45% of total S&P 500 market cap, surpassing levels seen during the Internet Bubble.
• The Magnificent 7 contributed 40–50% of S&P 500 earnings growth over the past year, with only a modest decline expected in 2026.
• Their share of capital expenditures rose from 12% in 2019 to over 30% in 2025.

AI hyperscalers’ investment as a share of GDP now exceeds the telecom industry’s peak during the Internet Bubble. Excluding tech, S&P 500 capital investment is barely expanding.

Large Companies vs. Small Companies

The divergence reaches beyond technology. Large companies generally have better credit access, more flexible supply chains, and greater capacity to invest in new technologies. This advantage is visible in earnings growth:

• S&P 500 earnings per share increased 10.6% annually over the last two years.
• Mid‑cap and small‑cap indices saw average annual EPS growth of only 0.5%.

Why the K‑Shape Matters

The concern is not primarily political or social but systemic. Healthy economic systems depend on balance. When segments of the economy move too far apart, the overall system becomes less resilient. While an economic collapse is unlikely, a continued widening of the K‑shape could increase vulnerability to shocks.

4Q25 Economic Review

Fourth‑quarter GDP data has not yet been released, but growth likely remained positive. The exact pace is uncertain:

• Atlanta Fed GDPNow: 5.3%
• Blue Chip survey: 0% to 1.9%

Reported data may be revised due to delays caused by the federal government shutdown.

Key themes from the quarter:

• A stagnant but stable labor market
• Slower but still positive consumer spending
• Capital investment concentrated in tech and communications
• Inflation easing slightly but remaining above 2.5%
• Two Federal Reserve rate cuts of 0.25%, with cautious forward guidance
• Strong corporate confidence despite policy uncertainty

4Q25 and Full‑Year 2025 Financial Markets Review

The Bloomberg High Yield Index led the way in 2025 with a return of 8.62%. Corporates were close behind at 7.77%. The Bloomberg U.S Treasury Index returned 6.32% and the Bloomberg Aggregate Bond Market Index returned 7.30%. The Muni Index returned 4.25% for the year.

Interest Rates and Other Markets

• UST 10-year 4.18% down from 4.58% at year-end 2024
• UST 2-year 3.47% down from 4.25% at year-end 2024
• Credit spreads: near historic lows
• U.S. dollar: down 8.1% for the year
• Oil (WTI): down nearly 20% in 2025

Outlook for 2026

The economy appears positioned for continued growth in 2026, supported by stronger‑than‑expected late‑2025 activity and several tailwinds. Recession risk remains low absent an external shock.

Key supports include:

• Fiscal aid for consumers and businesses
• Likely declines in short‑term interest rates
• Steady consumer spending
• Ongoing AI‑related investment
• Expected corporate earnings growth of 10% to 15%

Impact of the One Big Beautiful Bill

The bill should begin influencing the economy in early 2026:

• Consumers: Larger tax refunds—especially for middle‑income households—should lift spending.
• Businesses: Expanded tax incentives should bolster cash flow and capital investment.

AI Investment Outlook

Despite growing debate in late 2025 about the returns on AI investment, a significant slowdown in 2026 appears unlikely. AI‑related spending probably added at least 0.5% to GDP growth in 2025, though benefits remain concentrated.

Productivity Trends

Productivity rose sharply in Q2 and Q3 of 2025, allowing above‑trend growth without accelerating inflation. The underlying drivers are unclear, and AI does not yet appear to be a major factor.

Risks to Growth in 2026

Key risks include:

• Trade policy and tariffs: Additional passthrough to prices is likely.
• Monetary policy: Multiple rate cuts without economic softening could elevate inflation risks.
• Government involvement: Expanding federal influence—from deficit spending to market interventions—may distort resource allocation.
• K‑shaped divergence: Continued concentration of gains among high‑income consumers and large corporations could undermine stability.

Conclusion

We expect GDP growth of 2.0% to 2.5% in 2026, supported by the consumer and ongoing AI‑related investment. Inflation will likely remain sticky due to tariffs and fiscal stimulus. The labor market should remain stable, and the yield curve may steepen as short‑term rates fall faster than long‑term rates.

If AI‑driven productivity gains begin to emerge, the economy could receive an additional boost. Longer term, the key question is whether productivity gains will support broad‑based growth or primarily reflect reduced demand for labor.