Sun Life’s Chhad Aul explains how AI could undermine the wealth effect propping up markets and why this matters for plan sponsors
The economy keeps absorbing shocks that should, by most conventional measures, slow it down. Despite higher oil prices, geopolitical conflict and sticky inflation, none have produced the downturn that many forecasters have spent years predicting.
Chhad Aul, chief investment officer at Sun Life Global Investments, believes the explanation lies in a structural shift that institutional investors need to understand, because the same force propping up the economy could be the one that eventually breaks it.
The concept, Aul suggests, is the K-shaped economy, a divergence between upper- and lower-income cohorts that has widened over the past several years. Aul highlighted that the split has become more pronounced, with higher earners growing more confident even as those at the lower end trend in the opposite direction.
“An issue like this obviously has major consequences from a socioeconomic perspective in terms of wealth disparity, which we know is a problem on a number of levels. If you separate that from the investment and economic implications in terms of from a macro perspective, what's driving the economy is ultimately that upper part of the K. The asset owners, the ones who participate in the stock market and in asset markets, as well as those who tended to earn more, really drive the bus economically,” said Aul.
To that end, he stressed that institutional investors need to understand how improbable the economy's durability looks on paper. By several conventional measures, including this year's spike in oil prices, growth should have slowed more than it has.
The reason it hasn't, he argues, comes down to the upper end of the K-shaped split carrying a larger share of economic activity and holding enough of a financial cushion to absorb higher costs without pulling back on spending.
Why AI threatens economic resilience
However, the more pressing question for Aul's team is what ends the current cycle, which has been unusually long if the pandemic-era recession is treated as an exogenous one-off. His answer centres on whether the upper end of the K eventually faces the same pressure the lower end has carried for years.
"I think a lot of that can boil down to what collapses the K," he said.
Previous disruptions - financial, inflationary, pandemic-driven - have consistently hit blue-collar and lower-income workers harder, leaving the upper cohort's spending power intact. Aul believes AI may break that pattern.
Unlike prior shocks, AI-driven displacement could reach into higher-paying, white-collar roles, eroding the income and confidence of the group that has kept the economic engine running.
"Something that's happened over the last number of years is any crisis or sort of change that we've gone through has tended to hurt the lower side of that K more than the upper side. This time around, with AI disruption, that may impact some of the higher paying jobs to a greater degree," he said.
According to Aul, one of the more unexpected rotations this year has been the outperformance of small-cap stocks relative to their large-cap counterparts. On paper, smaller companies, closer to Main Street than to the AI buildout, he suggests, looked vulnerable as they stood to benefit less from the AI spending wave, faced greater disruption risk and absorbed higher costs from the surge in energy prices.
Yet, according to Aul, small caps have posted returns closer to 20 per cent depending on the index, roughly double the large-cap space. Part of the small-cap rally, Aul argues, reflects a market bet that energy prices will settle and that inflation won't persist - conditions that would disproportionately benefit smaller firms exposed to higher input costs. But he reads the rotation as signalling something broader: underlying economic resilience that runs deeper than most observers expected.
Consumers are indirectly investing in economy through wealth effect
The mechanism behind that resilience, in his view, is what he refers to as “the wealth effect”. According to Aul, household participation in equity markets has grown steadily over the past two decades in both the US and Canada, and the trend accelerated sharply after the pandemic.
Now, as more households hold equities, rising markets translate more directly into consumer confidence and spending. That mechanism has helped the economy absorb repeated shocks, everything from higher oil prices, geopolitical disruption and persistent inflation, without losing momentum.
Aul sees that dynamic as the primary reason the economy has shrugged off repeated shocks over the past several years, particularly as markets recover fast, spending holds up and the cycle continues. After all, investors appear to be pricing in a stabilization of the energy market, which would relieve the cost pressures that weigh disproportionately on smaller firms. The US, given its larger population and deeper market participation, amplifies the effect considerably.
"We think that's one of the main drivers here of the resilience in the economy, as we've seen markets recover really quickly and spending really holds up," he said. “What you're seeing is that greater impact of the wealth effect from more and more households participating in the market.”
AI investment exposure is migrating beyond hyperscalers
For pension plans that built their AI exposure through the “Magnificent Seven” or similar concentrated names, Aul suggests the next leg of value sits elsewhere in the supply chain, noting how energy production remains a bottleneck for the AI buildout.
Meanwhile, utility companies, he suggests, also still have room to run after strong gains over the past two years. Memory chip manufacturers have already ripped higher this year as the market identified them as the latest constraint in the semiconductor chain.
Ultimately, the broader point, Aul suggests, is that the AI investment story is migrating beyond a handful of hyperscalers and into sectors that don't fit the typical tech narrative.
"It's something that we probably won't even be calling a theme in the next year or two because I think it’s really pervasive and it's just going to flow right through into how we think about investments across the board, right down to individual company fundamentals," he said.
