MARK RIEPE: Welcome, everyone to Schwab Market Talk, and thanks for your time today. The date is April 2^nd, 2024, and the information provided here is for general information purposes only, and all expressions of opinion are subject to change without notice in reaction to shifting market conditions. My name is Mark Riepe. I head up the Schwab Center for Financial Research, and I’ll be your moderator today.

We do these events monthly and we’ll start out by answering some of the more popular questions that we get from different audiences. We’ll do that for about 30 minutes, and then we’ll start taking live questions. If you want to ask a question, you can do that at any point. Just type the question into the Q&A box, click Submit, and like I said, we’ll start answering those questions during the latter half of the show. As for continuing education credits, we’ve already got a couple of questions about that, live attendance at today’s webcast qualifies for one hour of CFP and/or CIMA continuing education credit if you watch for a minimum of 50 minutes. If you watch the replay, you aren’t eligible for CE credit. To get CFP credit, you’ll need to enter your CFP ID Number in the window that should be popping up on your screen right now. In case you don’t see it, don’t worry about it. You should see it again towards the end of the webcast as well. And then Schwab will submit your credit request to the CFP Board on your behalf. For CIMA credit, you’re going to have to submit that on your own. Approximately 15 minutes after the show starts, the directions for how to submit, they can be found in the CIMA widget that will be appearing on the bottom of your screen.

Our speakers today are Jeffrey Kleintop, our Chief Global Investment strategist; Liz Ann Sonders, our Chief Investment Strategist; Kathy Jones, our Chief Fixed Income Strategist; and Kevin Gordon, who is a Senior Investment Strategist.

We’re going to start out with some questions about the economy and maybe Liz Ann, I’ll start out with you. The core PCE came out last week. I think it was about 2.8% year-over-year. That’s not at the Fed’s 2% target, but certainly the trend is moving in the right direction. What do you think? Do you think the fight against inflation, do you think that’s on track?

LIZ ANN SONDERS: Yes, but not without some volatility. I’m not sure I’d say I’m a believer in the whole notion of the last mile being difficult. It’s just been a unique cycle, and there are a lot of cross currents. I guess the rub within the data, not just the PCE data, but the CPI data, is that the three-month annualized rate of change, the six-month annualized rate of change… and those are rates of change that Powell and others at the Fed have been emphasizing as a way to get a sense of the trend and cement the notion that, you know, assuming inflation gets down to or near their target, it has the ability to stay there… and those have ticked higher. Particularly, this year, for core PCE, that three-month annualized rate has gone from less than 2% to more than 3-1/2%, and that’s just this year. In the case of core CPI, that accelerating trend in terms of the three-month rate has actually been going on since last summer, where last summer it had a two handle on it. Now it’s got a four handle on it. And you combine that with what has been, obviously, a very healthy labor market, and that has caused the expectations now on the part of the market to be pricing in fewer cuts than what the Fed’s dot plot has pricing in. And that’s, obviously, starkly different from the early part of the year when the market was pricing in six or seven cuts and a March start.

So all of this is still a moving target in terms of Fed expectations based on the combination of inflation data and labor market data. And I’d say the next most important report on that subject of their dual mandate is, obviously, this Friday’s Labor Market Report.

MARK: Thanks, Liz Ann. Kathy, I want to turn to you. We’ve got inflation coming down, but the Fed hasn’t really moved yet. At this point, how restrictive do you think Fed policy has become on the economy?

KATHY JONES: Yeah, that’s a great point of debate, and both at the Fed and within, you know, financial circles. I think on the one hand what you can say is that, you know, we’ve had easy financial conditions in terms of credit spreads being very low, the stock market rising, economic activity has been very strong over the last couple of quarters, so that would suggest that maybe policy isn’t that restrictive. But if you look at in terms of where interest rates are and some of the knock-on effects of the higher interest rates, then you would say it is restrictive. So we have, you know, 300 basis points-plus a real interest rate spread right now. So you have a 5-1/2% Fed Funds, you have roughly 2-1/2- to 3% inflation rate, you’ve got historically very high real rates, and that is restrictive in the sense that what we’re seeing come out of that is rising delinquencies on credit cards, on auto loans, particularly among, you know, lower income consumers. I haven’t seen as much business investment, but financed growth the way you might have seen with lower interest rates, and certainly the housing market has felt it. So they are restrictive in terms of the real economic policy, but the financial markets have been easy, so that’s kept financial conditions easy. So it’s kind of a point of debate.

I think where we are now is, simply, the Fed has to take in all this information, follow the data, and remember that they still have a lot of room to play here because real rates are so high. So we’re still onboard with the Fed cutting rates later this year, probably starting in June or July, a couple of times, assuming inflation settles down a bit, and, of course, assuming, you know, we get some cooperation from the labor market data, as Liz Ann suggested.

MARK: Thanks, Kathy. Liz Ann, another wild card here is the banking system. About a year ago, we were actually talking about the stability of the banking system, and now we’ve got a lot of concerns being expressed about the impact of commercial real estate. It’s affected banks, and, you know, then that being a risk to the economy. So what are your thoughts on that?

LIZ ANN: Well, you know, it’s important to think of it in the context of what happened about a year ago with what we now think of as sort of a mini banking crisis, and the ability for the Fed to step in with their bank term funding facility and really ease any potential contagion there, alongside continuing to tighten policy, both in terms of the balance sheet and interest rate. So I think the Fed does have the ability to step in with their macro credential tools.

That said, what we are now dealing with is this maturity wall that banks are facing. There’s a real estate, commercial real estate advisory company called Newmark, and they’re out with data saying it’s about a $2 trillion wall of maturities between now and 2026, almost half of which is this calendar year, 2024. And of that 2 trillion, about a third of it would be considered significantly troubled.

But it really does vary from bank to bank. Just this morning, actually, a chart that we had circled, Mark, you may remember a week or so ago on this subject that showed the 20 largest banks and what portion of their overall loans were commercial real estate. Even within those largest 20 banks, you go down the size spectrum and find that those are the banks that have a much larger share of their loans in commercial real estate. And somewhat obviously, the troubled areas within commercial real estate… and there’s lots of categories, some of which are doing quite fine, but the troubled areas, no surprise, would be offices. But even there, there’s, you know, a pretty dramatic difference in terms of class A, class B, where you are regionally located, urban areas versus more suburban areas, but also multifamily residential, where you had seen such significant building.

Now, there are interested buyers starting to step in, but there’s still a decent gap between what sort of potential sellers are willing to take versus what the buyers are willing to bid. So that still needs to be worked out. But I think for anyone looking for either opportunity or landmines, this is an environment where you have to go company by company. You cannot look at this monolithically.

Now, banks are part of the financial sector, and I’m sure Kevin is going to talk about this, but we do have an outperform rating on the financials, but I do think you have to be particularly careful with regard to banks, and do that analysis, which is pretty easy to find in terms of how much exposure and where within the commercial real estate space it lies.

MARK: Thanks, Liz Ann. Jeff, I wanted to bring you into the conversation. One more economy question, and then we’ll start talking more about stocks. I don’t know whether it was last month’s call or maybe the one before that, you were talking about a lack of water in the Panama Canal, you know, kind of rebel attacks on shipping in the Suez Canal, and now we’ve got Baltimore’s Harbor, that situation. So what are your thoughts on kind of the impact of all these problems with infrastructure? What impacts are those having on trade, and how much will that kind of filter through to the economy?

JEFF KLEINTOP: Yeah, global shipping just can’t seem to get a break lately. When assessing the Baltimore Bridge collapse… well, it’s still early, but the disruption is likely to be focused on certain industries, like US vehicle imports from the likes of Volkswagen and BMW, and on coal exports from the US, primarily to India and Europe, like the Netherlands and Japan. They’re our big coal buyers, particularly from the Baltimore Port.

But already that port traffic has been rerouted. In theory, the Port of New York and New Jersey, alone, has enough spare capacity, as the total number of container units handled by that port fell by about 1.7 million last year. That’s more than the total 1.1 million handled by the Baltimore Port entirely in 2023. So I think we can absorb that East Coast port traffic. Of course, there are differences in specialized equipment that impact the actual capacity, but traffic is likely to be absorbed elsewhere.

Shipping is always something we watch closely, though. The Baltimore Bridge issue is relatively minor, but it adds to the overall challenges this year we talked about on the call. In fact, we’ve talked about it, I think, on every one of these calls for the last six or nine months. Of course, the Panama Canal troubles extend back to the El Nino issues, which began in the fall. The Suez Canal issues are, of course, tied to the Houthi rebel attack, which began the January. And another risk on the horizon could be the potential for a strike by Longshoremen at the East and Gulf Coast ports later this year, when that current contract’s due to expire. It’s in the fall. I think it’s in October, but usually in the three months leading up to that there are negotiations, there are often slowdowns that are unofficial, but they tend to reduce port throughput and result in delays. So if the past is any guide there, we could see additional challenges there. The rise in some commodity prices, like cocoa, is the result of weather, and the El Nino effects we previewed that were coming over the summer. So we have felt some of these effects, but, fortunately, we are starting to see some of the drought-related effects starting to end, the El Nino weather patterns should begin to lift very shortly here, and shipping costs, Mark, have been sliding over the past month from the spike that came with the rerouting of ships around Africa to avoid the attacks by Houthi rebels. So all that is some potential good news on trade and the inflation side of things as we look at the shifting situation.

MARK: Great, thanks. Thanks, Jeff. Why don’t we switch to stocks at this point, and I guess Liz Ann, I’ll start with you. US markets near all-time highs, notwithstanding yesterday and today. Are you detecting any signs of froth in some of the sentiment indicators that you check?

LIZ ANN: Yes, for sure. And there’s myriad sentiment indicators, and as many listeners and viewers know, we tend to bucket them in either attitudinal measures of sentiment or behavioral measures of sentiment. A classic example of a behavioral measure of sentiment would be AAII, American Association of Individual Investors. They’ve been doing their weekly survey since the mid- to late-1980s. And right now, there’s a pretty lofty share of bulls and a pretty low historical share of bears, so that’s a bit of a warning sign. Interestingly, AAII also tracks the equity exposure of those same members, and that sort of corroborates the attitudinal optimism being expressed there because exposure to equities has really shot up, and somewhat in part due to just appreciation in the market, but also maybe some of the buying. You have seen buying in areas like fund flows. Still, interestingly, more of a bias toward tech. Even though a sector like financials has had the strongest breadth relative to 200-day moving averages, that’s where you’re seeing the biggest outflows recently. So there is still that sort of rear-view mirror performance-chasing kind of tech bias in fund flows.

Other measures of froth or sentiment, both directly and indirectly, would be things like the put-call ratio, which continues to be fairly low, starting to uptick a little bit, but nothing extreme. And then volatility. It’s not a traditional sentiment indicator, but it’s sometimes called the fear gauge. And equity market volatility has been pretty subdued, but the VIX now has accelerated on the upside, just crossed above it’s 50-day moving average, its 200-day moving average, and may be a sign of a pickup in volatility… for lots of reasons—short-term market-related reasons, but also geopolitical concerns, and even political concerns, with emotional volatility fairly elevated, given that last I checked, it was an election year.

MARK: So as you look back on Q1, what are your thoughts on kind of the breadth of the market at this point?

LIZ ANN: Yeah, so the biggest improvement in breadth, as I mentioned, is actually come in areas outside of what were the dominant sectors that drove performance last year. You know, last year was dominated by the so-called growth trio of technology, communication services, and consumer discretionary because those are the sectors that house the Magnificent Seven, which, in turn, were big drivers of performance last year. A big difference in what the makeup of the market looks like this year. It’s why you’re hearing more references to things like the Fab Four or the Fab Five relative to the Magnificent Seven because of the weakness in stocks like Tesla, especially on a day like today, and Apple. But there’s been a lot of churn and rotation under the surface, which isn’t necessarily a bad thing because there was risk associated with the concentration last year. A lot of people don’t realize just how much churn has occurred under the surface, especially in an index like the NASDAQ. There’s performance tables and charts that I put on my Twitter feed every morning. And Kevin creates them bright and early, as he usually does, and they always go on my Twitter feed. But one of them is just a look at performance, both on the surface and under the surface. And an example of what’s happened this year is that NASDAQ is up about 10% year-to-date. It’s had no more than a 3% drawdown this year at the index level, but the average member within the NASDAQ has had an average maximum drawdown of negative 27%. And, again, that leadership shift in the case of the 50-day moving average, it’s dominated now by energy and materials, both of those sectors have 100% of their stocks trading above 50-day moving averages. Financials is the top of the leaderboard relative to the 200-day moving average. I think it’s close to 100%. I think it’s 97% of stocks that are outperforming the 200-day moving average. So a lot of rotation under the surface.

Last year was a year where there were concerns about recession and profits weakness. So investors really snuggled up to sort of this era’s defensive kind of names, those mega-cap, high-earning, high cashflow kind of names. Now, with the economy performing better, certainly in the US relative to the rest of the world, we’ve seen that shift of attention toward the more traditional cyclicals like materials and energy, and even financials, to some degree.

MARK: Thanks, Liz Ann. Yeah, Kevin, why don’t we bring you into the conversation? First of all, I think it’s your first time here. Welcome to the show. Liz Ann was mentioning some of the mega-cap names. I don’t think we’ve recently talked about small-caps. So what are your thoughts on small-caps? You know, why have they been struggling, and where do you think they’re going forward?

KEVIN GORDON: Yeah. Well, thanks for having me. Good to be here. You know, I think if you were looking at the spread between what’s happened in large-caps and small-caps, large-caps, you know, proxied by the S&P 500, small-caps proxied by the Russell 2000, you know, it’s twofold. The first part of it being what I think is really just looking at the trajectory of profitability. So if you look at earnings estimates, you know, a year out from now, and we track them on a daily basis, for the S&P 500, we’ve kind of come back into the uptrend that we were in pre-COVID. So you’ve made the round-trip now, and you’re moving higher. For something like the Russell 2000, you’re actually still in a broader downtrend. So the split there, I think, helps explain this, you know, drastic split in performance between the two indexes. And what was interesting is that when you made the all-time high in the S&P 500 earlier this year, in January, it was the first time that you made an all-time high in that index and you still had the Russell 2000 in a bear market. And so I think, you know, there’s obviously an odd nature to that because it’s never happened before, but I think it is also explained by the profitability trajectory.

And the second part of it being just the sector bias, and the sector makeup of those indexes. So there’s only one sector as of yesterday, as of a couple of days ago, and really just lately, that’s making a new all-time high in the Russell of 2000, and it’s the industrial sector. So that’s good news in terms of more participation. But if you look at the bulk of that index, you know, it’s dominated by financials and healthcare and consumer discretionary, all of which are struggling for their own reasons. And you were talking about the regional bank stress with Liz Ann earlier. You know, regional banks have a hefty weighing in the financials sector in the Russell 2000. So that alone helps to explain why indexes like the S&P have continued to do relatively well, not without some churn, while indexes like the Russell 2000 have really struggled.

MARK: Thanks, Kevin. You’re also kind of paying a lot of attention to the sector outlook. So, you know, what are the couple that you like? What are the ones that you think are going to be laggards?

KEVIN: Yeah, so we revamped sector views recently, as of a couple of months ago. So it’s a new model that combines, you know, our top-down qualitative approach with the bottom-up factor-based approach, courtesy of the models built from our friends over at Schwab Equity Ratings in the thousands of stocks that they rate. So it is great because we can get to these outperform ratings, which are now in financials, energy, and materials… so definitely more of a cyclical tilt… based on things like value, and growth, and sentiment, and quality, and earning stability. So the reason that the model is favoring those three sectors that I mentioned is, number one, all three score really well on value, two of them score really well on quality, and then you’re starting to throw, you know, a mix of growth in there, too.

So it’s kind of nice because it’s a little bit of a catchall, where a lot of these companies have had the earnings strength. Even in the energy space, earnings growth over the past year has been pretty dismal, but if you were measuring it over a longer term, you know, longer timeframe, earnings growth has actually looked pretty healthy for that sector. And then even for areas like the financials, you know, some of the larger banks and even financial institutions that are not banks have benefited from kind of the haven trade that was piled into a year ago, when you started to see more of the regional bank pressure. So those are the outperforms.

The underperforms are real estate and consumer discretionary. Real estate probably not as much of a surprise for many of the reasons you were talking about earlier with Liz Ann because of what’s going on in the office space. But for consumer discretionary, you know, it’s a mix of things. Number one, probably the first one I’d point out, being concentration risk, where you’ve got two of the largest members in that index, Tesla and Amazon, making up about 50% of that sector. So anytime one of those is moving, you know, significantly relative to the sector, you’re going to get an outsize move. You’re starting to see that with a name like Tesla, which is housed in that Magnificent Seven group, but is dead last this year in terms of performance.

MARK: Thanks, Kevin. Final question for you, and then we’ll go to Jeff. You heard earlier about Kathy talking about kind of her thoughts on what the Fed will be doing in terms of cutting rates. How do you think that’s going to impact sector performance?

KEVIN: Yeah, so one of the more consistent parts of Fed cycles and market cycles… and there’s not a ton of consistency going back in history because every Fed cycle, you know, is different, to some extent, especially when you look at the market’s behavior. But one of the things we’ve been able to draw out of them is that when you go into, you know, what is known as a slow Fed cutting cycle… so they’re not cutting aggressively, they’re taking, you know, sort of a slower pace, cutting incrementally maybe every other meeting… that actually, you know, from the first cut, what you see in terms of outperformance actually tends to benefit the more cyclical parts of the market. So think financials, materials, industrials, even tech, consumer discretionary, I mean, it’s almost everything except what is considered to be the traditional defensives, like consumer staples, and utilities, and healthcare. Fast cutting cycles, which is actually like the ones we’ve seen in the past three, you know, late… sort of 2019, 2020, and then global financial crisis, and then the tech bust… in those cycles at the outset after the first cut, you actually tend to see those traditional defensives do really well. So the broader cyclical part of the market is struggling, you know, much more relative to the traditional defensives.

So if we are going into a slower cutting cycle, which it seems like that’s going to be the case, probably bodes well for everything that has been doing, you know, better of late. If you were to put all of that in sort of that catchall cyclical category, it probably bodes well for that part of the market.

MARK: Thanks, Kevin. Jeff, there’s been kind of a ratcheting up of tension in the Middle East with some of the attacks, and in Lebanon recently. At what point does this get to kind of a level where it’s going to start to affect markets? I think in the past we’ve talked about, ‘Hey, if you can sort ring-fence conflicts, that’s probably a good thing.’ Do you think things are going to get out of control? And at one point, like I said, is it going to start affecting the global stock markets?

JEFF: Well, geopolitics tend to affect the markets primarily through oil prices. And we’ve seen that this morning, with Iran vowing a response to an airstrike in Syria that killed three high-ranking members of Iran’s Islamic Revolutionary Guard Corps. Today’s gains, a buck on West Texas Intermediate…. I’m looking at my screen now… $1.12. That follows a pretty solid rise in oil prices in the first quarter that was, in part, driven by geopolitical conflict. And that helped drive the energy sector, one of our favorites that Kevin just talked about, to being the second-best performer in the overall markets. But the oil prices, they may struggle to repeat that performance amid growing demand side headwinds despite the geopolitical conflicts. China, the world’s number two oil consumer, is likely to see soft demand, as its economy struggles to find momentum. Europe is the number three consumer of oil, and the benchmark diesel contract is down for the second month in a row, profits for turning crude into diesel, which is the fuel that is a bellwether for wider economic performance, something I watch closely, is also at the lowest in nearly nine months, signaling weak demand.

Perhaps even more importantly, the longer-term outlook remains muted. Oil demand will continue to rise in the years ahead, according to the Energy Information Agency, but the pace of demand growth is much slower than in recent years. And that keeps the balance of supply and demand tilted toward oversupply in the coming years, after just a brief drawdown in the current quarter, not to mention all the excess capacity out there that could be brought online in the event of a disruption somewhere.

So while we’ve got OPEC-plus, ongoing cuts, and any worsening geopolitical tensions in the Middle East or Ukraine could drive further gains in oil, investors may be reluctant to look past the demand side of the underlying situation here. And that’s seen even today. Oil, you know, up a buck on the rise in tensions. Tomorrow’s OPEC-plus decision may continue with output curbs.

And so despite all that, despite all the geopolitical tension over the past 10 years, oil hasn’t sustained a move above $90 in a decade, Mark, except for a few months following Russia’s invasion of Ukraine in 2022, when global supplies had to be reallocated. So with the global market being the primary… the oil market being the primary way geopolitical risks show up in the markets especially […audio dropout…] especially Middle East, sustain much higher oil prices […audio dropout…] from here on oil despite all the increased tension.

MARK: Thanks, Jeff. Kathy, I’ve got a couple of fixed income-related questions for you, and then we’ll start turning to a live questions. We got a lot of questions about the federal debt, the ongoing size of the federal deficit, you know, quite enormous, no signs that it’s going to be shrinking anytime soon. And yet the Treasury issues bonds. Bonds, people keep buying them. Who is the buyer these days for the Treasury debt?

KATHY: Well, it’s all the usual suspects. Nothing much has changed. So a lot of it is intergovernmental. But also in terms of external buyers, we have, you know, foreign central banks. They have kept up a steady pace of purchases over the years, despite all of the talking about threats to that. Insurance companies that have long-term liabilities, pension funds, particularly for the longer-term debt. Banks, depository institutions that have to hold treasuries as part of their capital requirements. All of these institutional buyers are there, and they continue to buy. As we auction more, they continue to buy more.

The biggest change has actually been in households. So US households have increased their holdings of treasuries pretty dramatically over the last couple of years as the Treasury issuance has picked up. And that’s largely because those yields are so attractive. So we know about the money going to money market funds. Money market funds often hold a lot of treasuries. So you’re seeing it there. You’re seeing it in other forms of holding short-term treasuries or agency securities, etc., mutual funds, which ultimately are held by individuals.

So the good news is… the bad news is we continue to run up more deficits and accumulate more debt. The good news is the buyers are there. And certainly at these yield levels, we’ve drawn in buyers that were off the radar for a good decade when yields were lower, and that’s domestic households have been more than happy to sop up a lot of this Treasury debt.

So I think, again, the balance is you can… we certainly need to address our long-term debt issues, but I don’t think it’s an immediate threat, and at these yield levels, and probably even a bit lower as the global cycle turns, we’ll continue to see the usual buyer step in and buy US debt.

MARK: Thanks, Kathy. Let’s talk about credit for a second. In the past, we’ve cautioned people that credit spreads have been relatively low, but they’ve kind of just gotten lower. So do you think it’s that to the point where that’s creating an exceptional risk from an investor standpoint?

KATHY: Well, it’s certainly increasing the risk. It isn’t at exceptionally high levels or at a point where it’s probably going to trigger some sort of real negative market reaction. But typically what you see in the corporate bond market is when the yield spread between high-yield, in particular, and treasuries get very narrow, it goes along, and it’s usually good times… economically speaking, it’s usually helpful to have the Fed easing policy to make the prospects of refinancing debt easier. And you don’t really see a winding of spreads until you hit some sort of a downturn in the economy or some sort of credit event, as we refer to it, where defaults start to pick up.

So right now, those spreads can stay narrow, particularly in the investment-grade area, where there’s less risk, anyway, to begin with on the corporate balance sheets. You know, the economy is resilient. Companies have been able to term-out their debt, meaning move the maturities out into the future. Private credit providers have stepped in to provide credit to the riskier parts of the market, and kind of taken them out of the market that is more visible, and that’s left somewhat stronger credits even in the high-yield space.

Nonetheless, you know, we’re still cautious as you go down the credit spectrum. Oftentimes, when those spreads in high-yield start to move out, when they start to widen, you don’t get a lot of warning. It’s because some event has occurred that has caused the picture to change. And so we’d just be very cautious at these levels. We think you’ll earn the coupon in the bonds, but there’s a risk of some increase in those spread levels at some stage of the game, particularly the lower you go down in the credit spectrum.

MARK: Alright. Thank you, Kathy.

Let’s take some live questions here. And Liz Ann, I’m going to send this one your way. ‘Regarding the AAII Sentiment Survey, what about the idea that bullish, even extreme levels, can remain elevated, as money on the sidelines finally comes back in as fear of missing out takes hold?’

LIZ ANN: So, in general, there is validity to that question. It’s part of the reason why when we talk about sentiment, we always remind investors that even at extremes of froth or despair, it doesn’t represent a market timing tool, certainly, with any kind of precision. And that goes, in particular, for periods where sentiment gets on the frothy end of the spectrum. All we have to do is remember, or look back at what was going on in the mid- to late-1990s. As a reminder, Alan Greenspan made his famous, or infamous, ‘irrational exuberance’ comment in the middle part of 2006… I mean 1996, and it was 3-1/2-ish years or so before the market topped out. So you can get sentiment move into extreme territory and stay there.

What it does represent is, all else equal, a risk factor, suggesting that you’ve got… you know, when sentiment is all on one side of the boat, to the extent there’s some sort of negative catalyst, the contrary move can be more significant than what even the fundamentals behind the contrary move would suggest is appropriate. So it’s more of a backdrop versus some sort of warning sign.

I’m not sure I like the terminology of ‘cash on the sidelines.’ You know, for every buyer there’s a seller, and it really has to do with the enthusiasm associated with buying pressure versus selling pressure. A lot of times these days, that sort of cash on the sidelines refers to things like the $6 trillion in money market funds. But relative to the overall capitalization of the equity market, it’s actually a fairly low percentage historically, even though the 6 trillion is just off of a record high in level terms. So you also have to think about that money possibly being sticky because it’s money that would otherwise or historically was in typical deposit accounts earning very little. Now it can move in and earn a more decent yield. And I’m not sure we should think of that as sort of an imminent source of buying pressure in the equity market side of things.

MARK: Thanks, Liz Ann.

Kathy, got I think three QT questions here. So, ‘Is there any evidence of the Fed continuing their QT efforts? Do you think QT will be reduced in May?’

KATHY: So the Fed is continuing its QT program of up to 95 billion a month in securities that are allowed to roll off. They don’t every month hit that cap, so it’s been a little bit below that. But the balance sheet is down over at 1-1/2 trillion from the peak and continuing to decline.

So what we heard at the last meeting, FOMC meeting, was that the Fed continues to believe that it can reduce the balance sheet even when it shfts to cutting rates. And there’s different impact of quantitative easing versus quantitative tightening, and they believe the impact of quantitative tightening is diminished relative to the impact of quantitative easing. So they feel confident that they would be able to continue this process for a long time.

Where the Fed will probably run into an issue is if there’s a tightening in liquidity in reserves, and then they probably would dial back the process of QT, maybe cut it in half, or cut it by a third, something like that, and continue to try to stretch it out slowly. I think that that’s a likely outcome as we get further down the road.

The second issue that the Fed faces with the balance sheet is that they have just a large proportion of mortgage-backed securities. Unless rates come down those mortgages… they have very long durations. Unless rates come down significantly, those mortgages are going to be sort of stuck on the balance sheet. It’s going to be hard to allow them to mature off anytime in the next couple of years. So I’m sure that the Fed has looked into that, and quantified it, and figured out how much it can tolerate. But that’s not a great scenario since the Fed has said they want to have an all-treasuries balance sheet again, but I don’t think there’s much maneuverability around that.

But yeah, it’s still continuing. Is it affecting financial conditions, particularly? No, it doesn’t appear to be. Is it affecting the economy, particularly? No, it doesn’t appear to be. We will see as we get a smaller balance sheet down the road whether it’s going to have an impact or not.

MARK: Thank you, Kathy. Jeff, this one’s for you. ‘When does the risk of a third front in Taiwan diminish?’

JEFF: Of a third front in Taiwan? So adding, you know, additional geopolitical conflict, I guess, in Asia. I think it has diminished. You’ve got an inauguration coming up in a couple of months here of the new president, which is just a continuation of the current party that’s been running for the last couple of terms. So there’s not a big changeover there. In the latest election, the Chinese Nationalist Party within Taiwan picked up seats in the Legislature. So it’s not like Taiwan is slipping away from China. And as a matter of fact, in recent polling, we’ve seen the percentage of citizens in Taiwan that want to declare independence, even eventually, way down the road, has been coming down steadily. So I don’t think China feels the need to act any time in the near term. Of course, their prepared act should they need to. They’ve outlined several times what the four red lines are that Taiwan cannot cross, include declaring independence, breaking off all talks about reunification with every party, engaging in a formal defense agreement with the US or other Western powers, and if Taiwan were to be invited and join the UN, or other similar multinational organizations at the same level as China. Those are the four red lines. None of those are on the agenda to be crossed anytime soon.

So I don’t see that erupting anytime soon. I see China continuing to put pressure on Taiwan, and adhering to the line that they, you know, continue to be one nation, but with two different systems. And I just continue to not see a conflict there anytime soon. Although certainly low-level threats and the potential for some conflict, small skirmish to develop because of that, the overflights and everything else going on, is always out there, but I put relatively low odds on that. I don’t think that’s something that China is interested in, particularly this year, given China’s unique economic situation.

MARK: Thanks, Jeff. ‘Kevin, what sector did you mention after you talked about financials and energy?’

KEVIN: Oh, so the third one is materials. So those are the three outperforms. I will say materials… you know, of the three, you know, one thing worth keeping in mind is that if we do see a stronger dollar, you know, for any reason, whether it’s interest rate-driven or growth-driven, you know, materials, of the three, definitely has the most exposure. And this is within the S&P 500, but has the most exposure in terms of foreign revenue sourcing. So that was one of the reasons that it struggled a lot, you know, a couple of years ago, when you really started to see the dollar gain a lot of strength. But I think it’s one thing worth mentioning.

MARK: Thanks, Kevin.

Liz Ann, let’s go to you for this one. ‘What do you tell clients who are worried about how the upcoming election will affect the markets, and how will the market react if the next administration doesn’t lift the debt limit?’

LIZ ANN: Well, I’ll answer the second part. I mean, we’ve seen the past couple of years, the, you know, down to the wire stuff with regard to the debt ceiling and, you know, concerns about default. And that’s kind of the name of the game these days, so I’m not sure that that changes significantly. And I think really key, not just that subject, but volatility in the market related to what happens is not just about the White House, but what the makeup of Congress looks like, and the high likelihood that majorities are going to be fairly narrow. So the one thing we’ve been reminding investors of, and Mike Townsend writes and talks about this all the time, is, you know, there, especially in a year like this year, is a big difference between policy proposals during campaign season and actual implementation of those policies because they’ve gotten passed post-election.

So we know it’s an emotional year. The statistic that we’ve all been citing that I think is really important to remember… Mike talks about this a lot… I’ve shown a chart of this… is that in kind of the modern era of the S&P 500, starting, I think, with the election around 1960, if you just invested $10,000 back then, when only a Republican was president, that $10,000 grew to $100,000… and I’m rounding here… as of the end of 2023. If you only invested when a Democrat was in the White House, the 10,000 grew to 500,000. Sadly, people stop the analysis there and say, ‘Well, I should only invest when a Democrat is a president,’ and maybe make a decision this year related to that because there’s five times greater return. But the real punchline there is that the same $10,000 invested at the outset, if you didn’t worry about whether, as I like to say, the Oval Office was painted red or blue, the $10,000 grew to 5.2 million. That’s the real moral of the story. It’s going to be an emotional year. Don’t let it come into the mix of what you do with your investments.

MARK: Thanks, Liz Ann.

Kathy, ‘Which of bonds look attractive these days?’

KATHY: Well, you know, obviously it depends on how you’re trying to put together portfolios for your clients and what their risk tolerance is. I would say from a valuation perspective, we’re probably looking at higher credit quality bonds, treasury agency securities. So, you know, MBS looks pretty good. You get a marginally higher amount of yield relative to treasuries of similar maturity. It’s not exceptionally high, but it is better than just straight treasuries. In investment-grade corporate bonds, we think the value is fair, although the spread is quite low. The nominal yields above 5%, I think, are attractive enough to say, yeah, that’s attractive for investors given the risk-reward profile.

When we look a little further out into things like emerging market debt, high-yield debt, etc., what we see is high-yield looks pretty highly valued at this stage of the game. As I mentioned, those spreads are very compressed, and that is raising the risk of some sort of a widening in spread. Again, though, in a benign economic environment that can continue a long time, and the coupon is very high. So for some allocation of somebody with a risk appetite, I wouldn’t say no to high-yield. I’d just be a little bit cautious there, and try to stay as high within the asset class as I can in terms of credit quality.

Local currency emerging market bonds may offer some value. Typically, when we get into the end of the cycle, where we’re starting to get rate cuts and you’re seeing a more benign global inflation environment, that tends to favor emerging market bonds where you do get a nice pickup in yield. I would lean more towards the local currency than the dollar denominated. Dollar denominated, the yields are not particularly attractive, and that universe is really dominated by one big issuer, China. So it kind of skews the diversification benefits there.

In the muni area, everything is highly valued. Demand for munis has been extremely strong, and continues to push those valuations up and those spreads versus treasuries down. But I would not shy away from investing in investment-grade munis, high-quality munis, if they fit a client’s profile. I would just say right now valuations are pretty stretched, and maybe a better entry point is coming down the road.

MARK: Kathy, since I’ve got you, we got one of our registration questions was what are your thoughts on TIPS?

KATHY: So TIPS have… I think the breakevens right now, that is the yield difference between a nominal treasury and inflation-adjusted treasury of the same maturity that makes you sort of indifferent, is roughly around 2% or so. So if you think inflation is going to be higher than that over the lifetime of the TIPS, then I would say that they can make sense. But keep in mind, TIPS, you know, you are really looking at the breakeven. You’re not looking at the absolute performance. And for a lot of clients to not get that a nominal yield is… getting the nominal yield is more important than getting the inflation-adjusted yield. So you have to think about it in those terms. But I think they’re fairly valued here. Particularly if you are in the camp that thinks inflation is going to exceed expectations over the next four or five years, there’s a place for them for that outperformance versus nominal treasuries.

MARK: Thank you, Kathy.

‘Kevin, which sectors are the most concentrated?’

KEVIN: Well, it’s really four of them that kind of dominate in terms of when you’re looking at, you know, the two largest names and how much they make up of the sector. So the three that are probably, you know, most well known… Liz Ann mentioned them earlier as the growth trio… are tech, communication services, and consumer discretionary. And actually communication services is the one that has, you know, the most concentration risk in terms of just the two largest names, which is Alphabet and Meta, make up more than 70% of the Communication Services Index. So that in and of itself, shows you that those names are going to push around the index, both to the upside and the downside, a considerable portion. This year-to-date, it’s so far bent to the upside, given some of the stellar performance, especially for Meta, but even more recently also Alphabet.

But the one that, you know, doesn’t get a whole lot of attention but is right up there in terms of about 44% of the index being just the top two names is energy. So Chevron and Exxon make up a huge chunk of the energy sector, at least for the S&P 500. And what’s equally as interesting is that their trends have actually kind of switched places throughout the year. So they haven’t both moved in the same direction. And that’s also the case for, you know, Apple and Microsoft in tech, and Amazon and Tesla in consumer discretionary, and then Meta and Alphabet in communication services.

So it kind of speaks more to the fact that yes, if you just took the two largest names in those four sectors, you have a lot of concentration risk, but at the same time, if you were more of an active stock picker and you were looking at names on an individual basis, sometimes you’re going to get a pretty significant difference in terms of the trend shift and what individual names are doing. So I would think about it more in those terms, not necessarily in monolithic terms, saying that, you know, all of tech is doing well or all of comm services is doing well. Oftentimes, with these sectors, it could be just one name or just two names that are actually carrying the rest of the sector, you know, much higher or much lower.

MARK: Thanks, Kevin.

Liz Ann, what do we tell clients to address their concerns about 2008-2009 happening again?

LIZ ANN: So I’m not sure whether the context is around the economy or the financial system, and, obviously, they’re interrelated. I think we got a flavor of this a year ago. We talked about what we now think of as the mini banking crisis and concerns at that time that via contagion it could become a problem, something similar to 2008-2009, and now maybe concerns tied to commercial real estate. But I already mentioned the tools that the Fed has, where they can step in and ease problems very specific to, like in the case of last year, the crisis that was brewing, with the failure of Silicon Valley Bank, Signature, and First Republic. And they did that alongside the ongoing tightening and monetary policy, so the Bank Term Funding Facility. And do have confidence that the Fed has those tools.

The big difference between the current environment, whether you’re talking about the problems of a year ago as it related to deposit flight or the problems now, and looking ahead with regard to commercial real estate, it’s just the overall health of the financial system. We have to remember that when the housing bubble burst in 2006 and 2007, because of the massive leverage embedded in the entire global financial system, and the trillions and trillions of dollars in the alphabet soup of derivatives tied into the inflated housing market, when that housing bubble burst, it literally and figuratively was a house of cards and took the entire financial system down with it. The financial system, not just in the United States, but globally, is much healthier. Leverage ratios are lower, capital is more ample. So I think any problems can be and are likely to be more contained than turning into the kind of ripple effect that 2008 and 2009 represented.

MARK: Thanks. Thanks, Liz Ann.

Jeff, I had a follow up to the question about Taiwan earlier. ‘Can you assess China’s attempts to kind of revive their economy?’

JEFF: Yeah, they suck, Mark. They’re not good at all. Sure, China’s official PMI for March beat expectations, manufacturing rose to 50.8 above that 50.0 threshold, which have been growth and recession for the first time in a while, and the privately produced Caixin Manufacturing PMI, which comes from S&P Global like all the others do, that rose to 51.1, kind of supporting the official growth reading. On the surface, that’s good news, but it’s not really. And that’s because while China’s growth is producing a greater supply of goods, there’s still weak domestic demand to absorb it all. Industrial production is accelerating, while retail sales are slowing. And it’s our belief that without further demand support, China’s economy may struggle to improve, and its stock market may continue to languish. I think there’s three things we need to see to turn China around.

First, a government guarantee of home buyer deposits at troubled property developers. That could help boost economic growth by turning around consumer confidence from its recession-like lows.

Second, I think loosening capital controls could help boost stocks by easing the ability of cash-rich companies, the big internet companies in particular, to do share buybacks. China’s very strict rules regarding moving money in or out of the country make share buybacks pretty challenging, since most of the earnings of these companies are generated in Mainland China, but the shares are listed in New York or Hong Kong. So it’s very difficult for them to do share buybacks. I think loosening that up could really help to list some of those stocks, which are actually trading right now pretty much right in line with the cash on their balance sheets, even though they’re growing institutions.

And third, I would say measures to reduce government regulations and encourage entrepreneurship could boost business confidence. We’ve seen years of abrupt policy changes, tough regulations on educational tutoring, on video game developers, business consultants, mobile app creators. They’ve all left businesses and entrepreneurs in an unsupportive environment.

Now, to be clear, there’s no signs of any of these three major imminent shifts in policy taking place in China, but China’s policymakers rarely signal those kind of moves in advance, and stocks in China are trading at a 20-year low PE ratio. So any surprises, any announcements along those lines could potentially trigger a sharp rebound in China’s stock market. But until that happens, if it happens, China may remain a drag on the emerging market index. It’s one of the reasons why emerging market stocks remain less attractive to us, Mark, than those in developed international markets.

MARK: Thanks, Jeff.

Kathy, these are a couple of questions about the 10-year. ‘What’s the upper range of the 10-year rate?’ And where do you… where’s the other one here? And ‘Where do you see the 10-year treasury yield going in the coming months?’

KATHY: There’s some resistance right around where we are today, around 4.35 to 4.40 on the 10-year treasury. If we were to see, you know, signs of accelerating growth and reaccelerating inflation, or inflation turning around to the upside, then we would price out fewer rate cuts by the Fed, maybe price them out entirely, and then the long end would move up. So you could create a scenario of going back to 4.80 or so on the 10-year. I don’t think that that’s the most likely outcome this year. I think we’ll start to continue to get that decent inflation news. But given the way the data had been more resilient than expected, I think upper end risk is somewhere at 4.80 this year. More likely, it stalls out under 4-1/2.

MARK: Okay. Kathy, I’ll give the last question to you. ‘Where do you see the dollar over the next 15 to 18 months?’

KATHY: Wow, that’s a long forecast time period for the dollar. Well, it’s been strong. It has stayed resilient, a combination of factors, mainly, you know, US outperformance, economically speaking, and because Fed policy has still been tighter than policy elsewhere. I had anticipated the dollar would start to come down as the Fed led on the major central banks for its easing policy in this cycle. I still think that that’s a reasonable outcome. We’re really not looking for a lot of downside in the dollar. Even as… say, the Fed cuts rates. There’s so much more room for those spreads to narrow before it has a big impact on capital flows. And in a world of heightened political tensions, all that’s going on, the wars going on around the world, there is a safe haven bid still for the dollar. So a modest decline from here is likely if we do turn this rate cycle and the Fed leads the way, I don’t think it’s a very big decline from here.

MARK: Thanks, Kathy.

And we are getting near the end here, so let’s wrap it up with maybe just kind of go around the horn, and everybody, just give me one thing that you want listeners to… or viewers to take away from the comments today. Liz Ann, why don’t we start with you?

LIZ ANN: Sure. So, you know, the Fed is important, but I think there is this idea that the market has been solely driven by expectations around Fed policy. I’m not sure that’s really the case. Last year, as I mentioned, I think one of the reasons for that sort of narrow focus was because of concerns about recession, particularly when we saw that… in addition, we saw the spike in yields, and that caused problems in the market overall. But when yields came down, you saw that improvement in the market. Now, this year, you have a situation where at the beginning of the year, you’re expecting a March start and six to seven cuts, and that’s eased, yet it hasn’t been to the significant detriment of the market. You’ve seen those rotations, leadership rotations, which are important, but I think that that just sort of proves the idea that the economic resilience has been more the story behind why the market has done fairly well, even as it adjusts to a changing expectation around Fed policy. So I think it’s really about the health of the economy.

MARK: Thanks, Liz Ann.

Kevin, what do you have to say?

KEVIN: I would say to be open to how maybe investors’ perceptions of certain, you know, pockets of the market have changed. And I know was discussed earlier, but the whole notion of what defensive looks like in today’s day and age, it’s changed a bit. It’s no longer really the staples of the utilities or the healthcare trade, you know, coming up as much. Especially if you go back a year ago when we had a lot of the stress in the banking system, almost overnight you really saw the piling into areas like tech, and communication services, and to some extent, consumer discretionary. So I think paying attention to what has become defensive in the era of the pandemic, or, you know, the post-pandemic era, has changed. Especially in a higher rate environment, you know, a lot of companies… a lot of mega-caps in areas like tech or comm services, you know, a lot of them earn more on their cash than they have to owe on their debt. So that, in and of itself, is a higher quality metric that a lot of traders and a lot of analysts and investors look for. So I would pay more attention to the factors that are driving outperformance, as opposed to what we think of in traditional sector terms.

MARK: Thanks, Kevin.

Kathy, any closing thoughts?

KATHY: I would say keep in mind that although we’re getting a lot of noise right now and… you know, stronger economic data, an uptick in inflation, a lot of fears in the treasury market... the fact is that the Fed does have a very high… has set a very high interest rate, and has probably 200 to 300 basis points in room to cut. And that suggests that it makes sense to extend duration to some extent, so that you don’t face reinvestment risk down the road. So even in a less than wildly bullish scenario, there’s room for rates to fall.

MARK: Thank you, Kathy.

And Jeff, we’ll give you the final word.

JEFF: Yeah, I’ll just say inflation remains a key focus to the markets. The Baltimore Bridge issue we talked about is relatively minor, but it does add to the overall supply chain challenges this year, which could threaten to revive inflation if they continue to worsen. And we’ll continue to keep you informed on the developments.

MARK: Thanks, Jeff.

And we are out of time. So Jeff Kleintop, Kathy Jones, Liz Ann Sonders, Kevin Gordon, thanks for your time today.

If you would like to revisit this webcast, we’ll be sending a replay… or an email with a replay link. To get credit for continuing education, you need to have watched for a minimum of 50 minutes, and you must have watched it live, so watching the replay doesn’t count. To get CFP credit, please make sure you enter your CFP ID Number in the window that should be on your screen right now. Schwab will submit your credit request to the CFP Board on your behalf. For CIMA credit, you’ve got to submit that on your own, and directions for submitting it can be found in the CIMA widget that’s at the bottom of your screen.

We’ll be back on May 7^th at 8:00 AM Pacific. Liz Ann, Jeff and Kathy will be back for that call. Until then, if you would like to learn more about Schwab’s insights or for other information about Schwab, just reach out to your Schwab representative. And thanks for your time today and have a nice day.

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