(Angela Weiss/AFP/Getty Images)
Bifurcation is the word of the summer. Or it's the word of the summer among investors, at least.
From analyst notes to earnings calls to CNN's own stories, the term, which describes the idea of something being divided into two branches or parts, is turning up everywhere.
That's because analysts think it describes the strange economic climate in the United States right now.
People at the top end of the income scale are still opening their wallets for dinners out, movies, vacations and big-ticket luxury items.
But Federal Reserve data shows that 80% of American households have less cash available to spend now versus 2019. Those who are earning less are feeling the brunt of that.
In short: The wealthiest are keeping the economy chugging for now, but fuel is running low.
At the same time, markets have been showing their own bifurcation: Mega stocks like Nvidia surge ahead while small caps get left behind. Frothy markets are usually seen as bad omens by investors.
Before the Bell spoke with Scott Wren, senior global equity strategist at Wells Fargo, about the word of the moment and what it means for the economy and markets going forward.
This interview has been edited for length and clarity.
Before the Bell: Last week was a strange one for markets. What's going on?
Scott Wren: (It was) a weird week because so much economic data came in better than expected. I think we're in a very sensitive timeframe where what's good for the economy is bad for the market because of Fed implications.
I've been around a long time, almost 40 years, and there aren't too many times you're going to see rate increases of this (previous) magnitude out of the Fed where you don't have a recession. While I think that the Fed did a terrible job by leaving rates too low for too long, I think that they've done a pretty good job here. The way that they can keep doing a good job is to not cut rates too early.
We've got two rate cuts priced in for this year and then one for next year. We think you're going to see inflation fall below 3% in the late summer, early fall, and that will give the Fed an opportunity to cut. But I think that the narrative that good economic news isn't necessarily good for the market is in play for now.
It just all comes down to inflation, and while the top 20% of Americans on the income scale are spending money like it's going out of style, there are a lot of people in the lower tiers that are struggling. Consumer sentiment might crawl a little bit higher like it did on Friday, but over the next six months I can't see confidence improving all that much.
You mention this stratification — often referred to as bifurcation. Bifurcation seems to be the buzzword of the summer.
I hate that word, but I use it, too. It's a word that the market gets hung up on and then all you do is hear that word. But it is true. You've got the top tier of wage earners versus the lower tier, you've also got large cap stocks just killing small caps.
That's what's happening now, and so bifurcation is the word we're stuck with.
Why is this inequality among consumers catching analysts' attention now?
Our economists tell me that over the last couple of years in particular, discretionary spending is really skewed toward the top end of the income scale. But our economists say that the discretionary spending at the top is not going to be able to keep pushing the economy along to the extent that it has.
People that are in the lower tiers of the income scale have been tapping into their 401(k)s and their home equity lines, they've been using credit cards. But I think that's nearing an end, and so I would expect a slowdown in consumer spending. Even at the top, consumers are being a little bit more picky.
I certainly think that we're going to edge up over 4% in terms of the unemployment rate, I think we're going to get a little bit of backup here in the pace of consumer spending, even on services.
Have you seen a split between high-income and lower-income consumers like this before? What's happened?
Usually it ends in recession. It's just like in stocks: Usually when you come into a big top in the market, it's a handful of really big cap growth stocks that carry you there. That's the way it is with consumers, where the big spenders at the top of the wage tier carry us into a strong economy.
But I think one difference that we probably underestimated was the magnitude of the effect of all this fiscal deficit spending that the government's doing. That's kept the economy going along. Just look around, so many airports are under construction, there's road construction all over the place. Those are high paying jobs, and we know that Americans with money in their pocket, they're going to spend it.
Two years ago, we thought there was going to be a recession. Clearly, there hasn't been, but there is going to be more of a slowdown going on in the economy.
I think typically it would end in recession, but with all this deficit spending that's going on it looks like it's just going to end in a slowdown.
Tell me more about the bifurcation you see in markets
If I think back over the last six or eight cycles, when you're coming out of a slowdown or a recession, about halfway through the slowdown, small caps start to outperform. It's really reliable that they outperform during the first couple of years of the new cycle. I'm not so sure that's going to happen this time because their balance sheets and cash flows aren't as strong. They need credit, and credit is tougher to get and it's more expensive.
I think at some point, you know, let's say in the second half of 2025 when the global economy is likely to be better, we're probably seeing a little bit of better growth for small caps here in the US, but I'm not sure it's going to be to the extent that they have grown in past cycles. As I look ahead over the next three to six months, it's hard for me to envision small cap stocks starting to gain ground on large caps.
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