LIZ ANN SONDERS: I'm Liz Ann Sonders.

KATHY JONES: And I'm Kathy Jones.

LIZ ANN: And this is On Investing, an original podcast from Charles Schwab. Each week, we analyze what's happening in the markets and discuss how it might affect your investments.

LIZ ANN: So we have said many, many times on this show that we are not here to offer political commentary. This is a market analysis show. However, there are definitely times when policy intersects with markets more directly. And on that note, I'll put in a plug here for our colleague Mike Townsend's podcast called WashingtonWise. The questions facing investors this week are centered around what might happen under a second Trump term. 

So it's certainly something that Mike is going to continue to address. And I thought we would at least touch on it here. You know, in my world, on the equity side of things, there's still a tremendous amount of focus, maybe heightened focus this week, on the Magnificent Seven group of stocks. And for those that aren't aware of that grouping, it's Alphabet, Apple, Meta, Amazon, Microsoft, NVIDIA, and Tesla. And we saw most of those CEOs featured pretty prominently at the inauguration. And in part, it's because each one of those companies is facing unique regulatory issues in this new administration. It may be part of the reason why at least some of the bloom has come off the rose of those names. In fact, I track this data on a daily basis and it makes it onto my X feed pretty much every morning. But if you were to rank on a year-to-date basis, all 500 stocks in the S&P. By the way, if you ever see reference to 502 stocks, that's accurate. But that's because two stocks, Alphabet and Berkshire Hathaway, have two classes of shares. So I just figured I would go off on a tangent and just explain that. But for this purpose, let's think of it as 500 stocks. And if you look at the Magnificent Seven on a year-to-date basis, the best performer, which is Tesla, is actually ranked 188. So there's a heck of a lot of stocks performing better than the best of the Magnificent Seven, and the worst performer among those seven is Apple, and that's ranked 497. 

So clearly in terms of performance dominance, a bit of the bloom has come off the rose, and it's in part because of some policy-related concerns, regulatory concerns, but also probably just some profit-taking, the fact that financial seems to at least be the start of this year one of the darlings in part because of very strong earnings so far for that group, and that's an area in terms of market dominance and concentration and where performance resides that we'll continue to write a lot about and speak a lot about.

Also, obviously in focus, and we've got a Federal Open Market Committee meeting next week, and I'll turn to you, Kathy, in terms of expectations for the Fed and fixed income markets, maybe how this policy uncertainty is infiltrating your world, including currency moves, dollar moves. So what are your latest thoughts?

KATHY: I think you could sort of say at this stage of the game, the markets are still giving the administration the benefit of the doubt. I think there was some real relief when the first day or two, which we're basically in, there was some fear there would be sort of a widespread tariff announcement coming out. And that didn't happen. There's a suggestion from Trump that there will be, though, 10% tariffs on Mexico and Canada starting February 1st. Nothing about China yet. So I think the markets are sort of breathing a sigh of relief and saying, "OK, maybe this is about negotiating and trying to get some concessions on various topics. And it's not going to be just this big hammer coming down in terms of tariffs." But it does still remain to be seen.

So 10-year yields have settled in right around 4.6% or so, which is down from the peak, but still elevated. And I think that the market is still not anticipating any change from the Fed at this meeting or really for the first half of the year, which I think is realistic because some of these policies will undoubtedly have an impact on inflation. So we look at tariffs in particular, if you assume that we will get some tariffs, maybe they're 10% of aggregate imports versus his previous administration was 3% of aggregate imports, that will add to inflation, probably less than one half of 1%, but we're already above the 2% target. So that's meaningful at this stage of the cycle. It also would be likely affecting lower-income consumers because those costs get passed along, and they're in things that lower-income consumers spend their money on, whether it's food from Mexico or basic goods that are necessary for day-to-day life. And so that's a concern as well. Immigration policy, looks like we're hearing more and more and more about that. 

Frankly, I think deporting all the immigrants would be very, very difficult logistically. It would be very expensive. And there's a lot of pushback from businesses that rely on imported labor. So I suspect there's some relief that, well, maybe that's not going to be as big an influence on the size of the labor force as feared. But it's still not clear. We still don't know.

And we'll have to see how that plays out. Same thing with taxes, as Mike Townsend has said many times, that takes Congress. That takes a long time. That's probably a 2026 issue, but that does affect the outlook for the budget deficit, all that being considered. So I guess I would sum it up by saying, right now, these risks to the economy and to the markets are still out there.

But when it comes to the bond market, they're kind of taking a wait-and-see attitude, being optimistic. The dollar, which was on a rip-roaring tear over the last couple of months, has kind of settled down a bit and again is kind of moving sideways. But a lot of what will influence it is not just tariffs and our policies and how fast we grow relative to everyone else, but can Europe pick up again? It's been a very, very sluggish year or two in Europe. Is China going to get back on its feet with all of its debt problems, and are these policies going to work? And then we have the Bank of Japan, which may actually raise rates at their policy meeting this week. So a little bit more settled tone to the markets, both in the currencies and in the bond market over the last couple of days.

But, I think this is just consolidating and waiting to see what actually happens because, you know, campaign trail is one thing, but actual legislation is another.

LIZ ANN: And then, you know, Mother Nature can come into play as well. I'm glad you mentioned the immigration piece of it, because I was reading some stats on California broadly, but the Southern California and the Los Angeles area specifically, and the construction workforce is close to 30% that are foreign born and undocumented.

So you have an issue, at least in that region of the country, where there clearly would be a lot of pushback given the upcoming need for that construction workforce to rebuild the Los Angeles area after the fires. I also read an interesting article recently about a very, very large farmer in Florida who is dealing with some of these workforce shortages. 

So this is where reality on the ground starts to maybe clash a little bit with those policy proposals, but we're all in a wait-and-see mode. It'll be interesting to me to see some of the survey data and whether opinions start to adjust. You may remember, Kathy, just a week or two ago, we got the monthly data out from the National Federation of Independent Business, NFIB for short, which really covers the small-business community. And the optimism component of that index went literally parabolic, just straight up. The only time in history we've seen something similar was when the lockdowns started to end in COVID. And you had seen, I don't want to say an artificial plunge in confidence, it was a COVID-related plunge, but you got that V-shaped rebound. This one was a little bit different, and it was clearly election-driven. The NFIB members tend to be more GOP-leaning, and we did see something similar in that optimism index and the soaring that happened in the aftermath of the 2016 election, but given the various implications and potential hits from all the policy proposals, that's something I'm going to be watching closely is the differential between what we think of as "soft" economic data, survey-based data, and "hard" economic data. In fact, our colleague Kevin Gordon and I just, our latest written report, which we just published earlier this week, is on just that subject, the differential between the soft economic data, survey-based data, and hard economic data. So check that out if you haven't already seen it.

KATHY: I actually did read it. I thought it was really interesting. A lot of good graphics in there as well. But one thing I would say that seems to unite everybody in business is this idea of reduced regulation. And that seems, I think, from my amateur reading of the stock market, a lot of that is benefiting the bank and finance sectors because they're hoping for some relief on the capital requirements at the banks, which would allow them more capital to lend and, you know, do all those things, and I wonder, though, I'd love to get your take. In some industries, you can reduce regulation, but a lot of what affects a lot of industries, a lot of businesses, is local. It's not the national sort of … 

LIZ ANN: Not the federal. Yep.

KATHY: … right, top-down regulation, so construction, you know, most of the regulations on building, home building, are local, right? State and local governments have a lot of oversight there and requirements. So I wonder, besides finance, which seems obvious to me, are the other sectors of the economy, other industries that would really, you know, stand out where federal or top-down regulation would help?

LIZ ANN: Well, in general, where you're seeing the most enthusiasm is not industry-specific but size-specific. So the idea of the deregulatory part of the agenda being more front-and-center that has given a lift to small-cap stocks again. But that's actually a really good question and something probably worth us diving into is where you get that differential between the benefits accrued from federal deregulation versus the reality on the ground at the state or local level. I've had just an interesting sight into exactly that. So my husband is soon to be the president of our property owners association. I know, I know.

KATHY: He didn't agree to do that, did he?

LIZ ANN: He asked me whether … he's retired now, and he asked me whether I thought it was a good idea for him to consider it. I said, absolutely, give you something interesting to do. And I'm not sure whether he's ultimately going to thank me for saying "do it" or give me a hard time. But just overhearing him on calls and understanding even within the local area, the differences in regulatory requirements just at the city of Naples versus Collier County, the county in which the city of Naples sits. It's extraordinary. So you're absolutely right. There are so many companies that might be sort of cheering just the concept of a less regulatory-strict environment, and the costs associated with that because smaller companies do have that as a larger portion of their cost basis, and in turn, those costs collectively, not just regulatory costs, are a larger share of their top-line growth. Hence the, you know, lot of "rah rah" is measured by some of those confidence surveys. Good question is whether the reality of how much that filters down into their own business. I think could change that, what has been a huge divergence between, again, that soft data and the hard data. But I'm glad you posed that question. That's worth a further look. So I'm going to put that on my to-do list.

KATHY: Yeah, as someone who grew up with a family business, a lot of the regulation was really local, very, very extremely local. And I can remember conversations about "why did they do that?" So I think that will be an interesting distinguishing factor, probably in performance, for some companies.

So Liz Ann, it's look ahead time. We do have a Fed meeting next week, and I'm sure we'll discuss that more on next week's podcast. But what else is on your radar? Are there earnings coming out for 2024 still?

LIZ ANN: Oh yeah, lots of earnings. So we're still fairly early in earnings season. We got through most of the big financials, and that can be and has been market moving. And the good news is, even though it's still fairly early, we are seeing very positive metrics, the typical metrics that are being tracked. It's a moving target every day, so it's hard to pinpoint, especially given we're taping this two days before it's going to air, but call it somewhere in the low 80s in terms of the percent of S&P companies that have beaten earnings estimates so far. Less positive beat rate, as they call it, on top-line growth or revenue growth, that's more in the low-to-mid 60s, and that's been a trend that's been ongoing. From the start of earnings season before the first company reported, the expectation was for 9 to 9.5% earnings growth overall for the fourth quarter. That's for S&P 500®. That's up to about 10.7, 10.8% now. And that's called the blended estimates. So it's the companies that have already reported their actual numbers blended with the consensus estimates for companies that have yet to report. So that trend is positive. The only rub being that estimates for every quarter in 2025, in general, have been trending down. So we're getting a decent quarter relative to lowered expectations. But I think from a market perspective, we probably need to see some leveling out in calendar year 2025 estimates. But there's also a lot of economic data coming out next week. There's housing-related data, we get new home sales, building permits, which is a key component of leading indicators.

We've got home prices, a variety of metrics that track home prices, including S&P Case-Shiller, the Federal Home Loan Foundation. They put out price data, so we'll be looking at that. We get durable goods. Consumer confidence comes out, put out by the Conference Board. We've got mortgage applications. Obviously that ties into housing too.

The trade balance numbers, times in the past don't tend to take on a lot of importance or get a lot of focus, but in light of trade policy and tariffs, that might be more in vogue to keep an eye on. We get a look at GDP, and we get personal income and spending. And then I think also, you may know this, I think we get PCE, the Personal Consumption Expenditures Price Index, which is the Fed's preferred measure of inflation, and if I'm correct, I think that comes after the FOMC meeting. So the Fed will not have that in their possession at the time they make their decision, which is probably to do nothing next week.

KATHY: You're right. They won't have that information, although they'll certainly have a pretty solid estimate of what they think it's going to be. So I don't think it's going to be, well, no one's expecting them to do anything at the meeting anyway in terms of changing rates. So I don't think that's going to be an issue. Sounds like, yeah, we have that mix of soft and hard data that you're talking about. So after a little bit of a respite over the last couple of days, we're back at it with the economic data and trying to get a handle on what 2025 is looking like. In terms of the Fed, again, no one's expecting a rate change. It would be very surprising. We don't get the summary of economic projections, or dot plot, this time around. 

So the focus is really probably going to be on the Fed Chair Powell's comments after the meeting and the press conference. And I think the best guess is he's just going to try and punt on most of the hypothetical questions and say, "Well, we'll just wait and see what comes down the pike, and then we'll react to it." And I don't know what else he can say at this stage of the game, given the level of uncertainty about what policy is actually going to evolve into. I do think I'll be interested if someone could ask him about the balance sheet. We have had quantitative tightening. That is where the Fed is allowing bonds to roll off its balance sheet, reduce its holdings. That's gotten to a pretty significantly low level. And there is a question of if you get too low, are there enough reserves in the banking system to avoid some sort of pinch point that we've seen in the past? I'd be curious to see if there's any updated thoughts on that. We had thought they would end quantitative tightening pretty soon, early in this year. But it's looking like there's still ample reserves.

And so perhaps the Fed will just continue to allow that to happen and just wait and see on that one as well. But I'd be curious to see if there's any update on that. We will be getting mid-year, I believe, a new kind of set of assumptions, format, policy review from the Fed. They do this every so often. It'll be interesting to see if there's any conversation about that when we get the minutes of this meeting. But it's all punting right now. Kind of waiting to see, and markets have definitely decided Fed's not going to move policy anytime soon.

LIZ ANN: Well, you know, on that note, to me, what will also be interesting is, particularly if in the aftermath of a meeting where we assume nothing is going to be done, whether Trump ramps up some of the rhetoric against either Powell or the Fed, because he clearly has stated he wants lower interest rates. And we all remember, I think it was the November FOMC meeting and the Powell press conference where, because that was right around the time of the election, Powell was asked a couple of different ways about what the power of the presidency is in terms of being able to demote him or fire him. And he was pretty firm in his, "They don't have that power, and I'm not going anywhere." So I think that could be a headline grabber, particularly if there is any anti-Fed or anti-Powell commentary from Trump, how he handles that in the press conference, relative to questions that I think, under those circumstances, would inevitably come from reporters.

KATHY: Well, Powell's term is up in a year. And best guess, I think, in the market is that the administration will just wait it out and then appoint someone they like better. We know that Miki Bowman has been a favorite from the administration. It could be Waller. I think there are probably some rehearsing right now and trying out for that position. We'll probably see more of that over the next 6 to 12 months as this plays out. But I don't think, it's probably not a war that the administration wants to fight with the Fed. I think that the various people on the economic side probably have advised to just put this off. We're going to have runway down the road to make changes at the Fed if we want to in terms of personnel, and let's not fight that fight right now because the markets would not like that very much at all. 

So that's it for this week. I want to thank everybody for listening. As always, you can keep up with us in real time on social media. I'm @KathyJones—that's Kathy with a K—on X and LinkedIn, and you can of course read all of our written reports, including charts and graphs, at schwab.com/learn.

LIZ ANN: And I'm @LizAnnSonders on X and LinkedIn. My standard public service announcement: I am not on Facebook. I'm not on Instagram. I'm not on WhatsApp. I'm not, at least not yet, on BlueSky. So if you see me on there, it's an imposter. I've had a rash of those, including imposters that use AI-generated videos that look like me. They are me, it's my voice, but the words coming out of my mouth are nothing I've ever said, so don't get scammed.

But back to our show. If you've enjoyed it, we'd be really grateful if you leave us a review on Apple Podcasts or rating on Spotify or feedback wherever you listen, and you can follow us for free in your favorite podcasting app. And we will be back with a great new episode next week.

For important disclosures, see the show notes or visit schwab.com/OnInvesting, where you can also find the transcript.