The K-Shaped Economy: Where Are Markets Headed in 2026?

Welcome to the K-shaped economy, defined by a bifurcation in economic sentiment and outcomes. The letter “K” captures the divergence: the upward-sloping arm represents higher-income households, supported by rising income and wealth, while the downward-sloping arm reflects low- and middle-income households facing stagnant wages, rising living costs and heavy debt burdens. In this two-speed economy, consumer segments and the businesses (or business lines) serving them are growing at different rates.

In the U.S., where consumer spending makes up over two-thirds of GDP, this bifurcation has implications. Higher-income households now drive much of the activity: in Q2 2025, the top 10 percent accounted for nearly half of all consumer spending. Economic resilience has grown more concentrated among the wealthy, who have benefited most from asset price gains. As a result, softer labour-market data in 2025 drew less concern, as the weakness was felt mainly by lower-income households, who had a limited impact on aggregate consumption.

Canada’s picture is more nuanced. Household spending remained resilient in 2025 but was challenged by heightened trade uncertainty, slower population growth and a cooling labour market. While U.S. tariffs have weighed on exports and jobs in affected industries, substantial new spending announced in the Federal Budget is expected to offset some of these pressures.

What Lies Ahead for Economies and the Markets?

Looking to 2026, questions remain about the trajectory of economies and markets. In 2025, artificial intelligence (AI) was a key catalyst for market optimism. Debate persists around whether massive capital investments will deliver meaningful productivity gains, though some suggest expectations are already partly reflected in equity valuations. If consumer spending endures and investments begin to show real returns, markets are likely to continue discounting labour-market weakness, looking past the lower arm of the K.

At the same time, monetary stimulus from interest rate cuts in both Canada and the U.S., combined with tariff renegotiations and potential U.S. tax refunds, could help stabilize labour markets and support more exposed sectors. However, some argue that this same stimulus has further widened wealth inequality.

As equity markets reached new highs in 2025, many investors have asked: Are stock prices running ahead of fundamentals, or is there still room to grow?

Market performance is influenced by many forces—government policies, geopolitical events, economic growth, inflation, interest rates and even the headlines. But over the long run, corporate earnings remain a significant driver. Here, the story has been strong. U.S. corporate margins have risen, with the average S&P 500 net income margin now above 10 percent this decade, roughly double that of the 1990s. Canada has followed a similar trajectory, though aggregate corporate profits have been more sensitive to commodity prices.

Several tailwinds suggest that growth can continue: technological innovation, productivity improvements and resilient consumer demand all support sustained profitability. Still, history offers caution. In the 1970s, despite a decade of solid earnings growth (9.9%, chart), persistently high inflation and global energy shocks kept equity markets subdued. Even so, today’s strength in earnings remains a key foundation of market performance that shouldn’t be overlooked.

As advisors, we continue to navigate the evolving landscape. The K-shaped economy reinforces the value of time-tested principles— diversification, a focus on quality and disciplined risk management— as key to successful long-term wealth management in an increasingly uneven economic environment.

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