KATHY JONES: I'm Kathy Jones.

LIZ ANN SONDERS: And I'm Liz Ann Sonders.

KATHY: 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: Hi, Kathy. So this week we are marking a bit of a special occasion—for us anyway—hopefully for our listeners. It's been one year since we started this podcast. So we thought this week we'd take the opportunity to step back from the weekly churn of data and indicators and news and reflect back on the past 12 months and see what's changed. So Kathy, looking back on it, how would you summarize the past 12 months in terms of your world, fixed income investments, rates, volatility, and everything else?

KATHY: I think the word that comes to mind is roller coaster, Liz Ann. You know, and I look back over the past year, what we see is that the fed funds rate 12 months ago had reached that peak level of, you know, 5.5% for the upper bound and was stuck there. And although there were hints that it was going to come down, we didn't know when and how much and how fast.

And obviously, subsequently, it took a long time for the Fed to get around to start cutting rates. The expectation was at that time it would start sooner rather than later. But we were stuck there for a while. And you know, the interesting thing was two-year yields a year ago were at 4.90. They got all the way down to 3.6. They actually fell, came back, fell again. And now they're back up to 4.25 or so, 4.30.

So we've kind of done this almost-round-trip twice. Same with 10-year yields. They started out at 4.90, got down to 3.80, went to 4.75, got to 3.60, now we're back at 4.30. It's just been this churning and pretty volatile time period. But what's interesting is apart from that, break-even rates, the embedded implied inflation expectations that we thought would derive from the Treasury Inflation Protected Securities market, the TIPS market, those haven't changed that much. They had very mild sort of up-and-down, but it's still right around 2.25, 2.3%. That's kind of where it's been stuck the whole year, just very little volatility.

So despite the moves in rates, despite all of the excitement that we've had in the markets and the volatility, the embedded inflation expectations really haven't changed that much, which is interesting. The other thing I think is, you know, inflation has done what we had hoped it would do. It has come down, mildly. And that's also a bit reassuring. Maybe that's why the inflation expectations have been kind of anchored around 2, 2.5%. And all this happened while the Fed balance sheet came down by over a trillion. And we added about 2.4 million jobs over the past year. So lots of activity. But when we look at where yields are right now, kind of edging back up to the upper end of that trading range we've been in, not all the way up. But we haven't gone that far, I guess, at the end of the day. We've traveled far, but we haven't gotten that far. How about you, Liz Ann? Looking back on the equities market, I mean, you've also had a bit of excitement over there in that part of the world. How would you recap the past year?

LIZ ANN: Yeah, so it's really been sort of a tale of two markets in a different way in the first half of the year relative to, so far anyway, in the second half of the year. So the first half of the year really through the initial surge to all-time highs, which occurred in mid-July was one of incredible concentration and dominance on the part of the mega cap tech and tech-related names often bunched together in that "Magnificent Seven" moniker, but even there I think the story has changed a bit because in 2023 those stocks were the seven largest stocks and they were also all very strong performers. In 2023 you only had to go down I think to rank number 62 out of the 502 names in the S&P 500® to capture all seven of the Magnificent Seven. That was not the case in the first half of 2024, where you had some big laggers, notably Tesla, within that group of stocks. That said, if you think more broadly about just mega-cap tech and tech-related, the growth trio of technology and communication services and consumer discretionary, that's where pretty much all the performance was. And I don't remember the exact point. I think it was sometime in June, you had some record-breaking numbers in terms of the share of performance accounted for by a very small subset of names at the same time, a record low percentage of the index, in this case, the S&P 500, that was outperforming the index itself over the prior one-year period of time. And that was one of the things that we were pointing out to investors is that having a market that is dominated by cap-weighted indexes like the S&P 500 or the NASDAQ, having performance biased up the capitalization spectrum or in a relatively small handful of names, is not abnormal. That's happened many times, particularly in bull markets. It certainly happened in the latter part of the 1990s. It becomes a bigger problem when the rest of the market is sorely underperforming. And that was the extreme that we saw in the first half of the year. And then mid-July came, and it was a confluence of things that unfolded, some concern about earnings in the AI space, not so much the reports for second quarter, but commentary around investments in AI and maybe a bit of a timing gap between the expenses associated with investments in AI and the revenue generation or productivity benefits accruing from that. That might have been the most fundamental reason why you started to see a bit of rotation, you also had the unwinding of the yen carry trade, a number of forces that kicked in a bit of a corrective phase between mid-July and early August, culminating in that very funky day in early August, August 5th, I think it was, where, in that one trading day, you had a record-breaking intraday surge in the volatility index, and on that same exact day, you had a record-breaking intraday decline in the same volatility index. 

So that was sort of the crescendo point in time, at which point you had gone into correction territory for the NASDAQ. You weren't quite there for the S&P. But the rotation really started. And you initially saw a move away from, you know, mega-cap tech and tech-related into interest-sensitive areas. That was also around the time where we started to get the telegraphing by the Fed of a move to easing monetary policy that provided a lift to the interest-sensitive segments of the market. So you saw leadership shift to real estate investment trusts and financials, utilities in addition, although utilities has been a strong performer all year, in part because it's seen as a bit of an AI play. 

But then you've seen rotations since then into other areas of the market. You've seen rotations at times, shorter-term rotations, into the more traditionally defensive areas like health care and consumer staples. You've seen rotations into more globally cyclical areas like materials and industrials, especially when we got some of the stimulus news out of China. So one of the themes that we have had is that we expect these rotations and this broadening out to have legs, but it's not binary. We didn't just go from a Mag Seven–led market to some other segment of the market. You've seen these now more above the surface rotations happening at times, frankly, back into the Magnificent Seven, back into the mega-cap tech and tech-related names at times. So just this, sort of more above-the-surface churn is something that we expect to continue for a while, whereas in the first half of the year it was more below-the-surface churn. But to highlight just how much churn there has been, as I mentioned, we did get a correction in the NASDAQ to the tune of 13% in that mid-July, early August period. But the average member within the NASDAQ has had a 45% maximum drawdown this year. It's nowhere near as extreme for the S&P, but even in the S&P, the average member maximum drawdown this year is almost 20%.

So it really has been a tale of two markets depending on what segment of the market you're looking at. And I think that helps maybe to explain to investors who are so confounded by all of these uncertainties of the macro variety, geopolitical, inflation, economic, Fed. "Boy, how can the market have been so resilient and just sort of continue to move to all-time highs in the face of all of this?" But the reality is, I think a fuller story gets told if you look beyond just the surface of these cap-weighted indexes, and there you see a little bit more of a connection to some of that uncertainty. So that's been the way I've thought about this market. Definitely a different look to this market in the second half of the year relative to the first half of the year, and not a bad thing because I think a market where you have broader participation even if it's of the rotational variety is a healthier market than one that just stays highly, highly concentrated without a lot of participation from other areas. 

KATHY: You know, one of the things we saw in the credit markets is credit spreads have stayed very tight, both investment-grade and high-yield. I think not only does that reflect the financing has been available—the liquidity is there, and there's eager lenders out there—but also the corporate profits have done well. You know, when I went to school, supposedly the stock market was … evaluation was based on earnings and earnings expectation. And it does look like, when we look back at the data, those earnings have come through. So I think that that too seems to be supportive of your comment that it's been a lot of churn, a lot of rotation, but underlying it, it looks like those earnings have been pretty solid.

LIZ ANN: They have been solid, and what you can also do is look at the performance breakdown, particularly during earnings season, of companies that are reporting better-than-expected earnings, both on the top line and the bottom line, that have been able to maintain or protect profit margins. The reward spread is pretty significant. Whereas the hit, two stocks that are on the other end of the spectrum, they either miss on earnings or have those double misses where they miss on both top-line growth and bottom-line growth, can't protect those profit margins. And that becomes a bigger problem as you go down the cap spectrum. You know, 43% of the Russell 2000 right now are negative earnings. That's a pretty high percentage, given a pretty strong overall earnings profile, but clearly the benefit has accrued more toward those larger companies, and that helps keep the overall earnings picture, especially given that we measure it typically via the S&P 500, which is a large-cap index, but there's another part of the story here, which is smaller companies that have struggled a bit more, and I think that that has been another fundamental support for the larger-cap bias within the equity market is just how much stronger the earnings profile is.

All right, so Kathy, let's reminisce a little bit as we celebrate one year of doing this together on almost an every-week basis. So we've certainly covered a lot of topics. The Fed has found its way and woven into pretty much every one of our conversations, I think, this year. We've talked a lot about how unique this cycle has been in this pandemic, post-pandemic world, and rolling recessions and recoveries, the somewhat suppressed volatility in the equity market, a bit more volatility in your world and the fixed income market. We've talked a lot about markets, but also the economy and the consumer and inflation and we've even had to talk a little bit about politics. We tend to keep those segments short, and often we'll pitch our colleague Mike Townsend's WashingtonWise podcast for people who want to dive into that. But we've had some really memorable topics that we've tackled with guests as well. We've had some really special guests, one of my favorites and probably yours, we're biased a little bit, but was Chuck Schwab, our founder and fearless chairman. Those conversations are always interesting. I got to sit down with Scott Galloway for a pretty far-reaching conversation. And he talked a bit about his book. He's obviously a very popular podcaster himself and always has intriguing ideas. My friend Mellody Hobson about participating in corporate boards and her involvement at Ariel. You had the great Claudia Sahm twice. We've had Ed Yardeni. There are so many. So what's most memorable to you, Kathy, about the last year of our podcasting?

KATHY: I'll have to admit when we started, I was pretty nervous about it. I wasn't really sure I had the talent or the wherewithal to do this just because it was new to me. And so I'm glad that people have liked the podcast generally speaking and that we've been able to get some just fabulous people. You've named a bunch of them.

And there were more. We had Julia Coronado, terrific economist, on. I hope to have her back on again. Many of our colleagues have been on, who we get a chance to kind of shine a light on how talented some of the Schwab folks are. We've had people from Schwab Asset Management. We've had my colleagues, Cooper Howard and Collin Martin. I know you've had Kevin Gordon, your buddy, on here.

So it has been fun to find how popular it is and how much people really are interested in the content. And I guess the other real memorable thing for me is the reaction we've had from Schwab clients and various other people who've kind of reached out and said, "Thank you, this is just what I needed." Or, "Hey, how about this idea?" which is usually a really good idea because it's things people are asking about or people are interested in that we can comment on. So it has been a lot in terms of getting prepped every week for this and keeping up to date with a lot of interesting people, but it's been a real opportunity, and I've gotten over most of my fear, not 100%. You know, there's always a little bit of nerves before we go on the air with this and start the topic. 

But I think all in all, just a lot of great guests, a lot of great information, a lot of great chances to just chat about what's going on in the markets in a way that's not too structured, it's not too time limited. It's just, talk about it and keep on top of it. And having the positive reaction from a lot of folks has just been fantastic.

LIZ ANN: Yeah, I'd say one of the overarching comments that we get from people who are kind enough to post a review or send us a note is they like the conversational aspect of it. And I guess one of the disadvantages to doing this audio-only, although as we're doing this right now, you and I can see each other. We can see our production team, but our listeners can't see. Isn't there our podcasts which are done on camera? And I'm not suggesting we switch to on camera because then it puts Kathy and I in a position to have to do hair and makeup on days where we otherwise don't have to do hair and makeup.

KATHY: No way, no way, Liz Ann, not doing that every time.

LIZ ANN: There are times where we're in hair and makeup anyway, for other things that we have to do. But if you could see us, you'd see that we're not reading off of long scripts. It truly is a conversation between us. You're absolutely right. There's often a lot of prep that has to be done in advance when we're sitting down with an external guest. I remember back-to-back episodes, we had one on residential real estate with the great Dolly Lenz and then commercial real estate with my friend Al Rabil, and certainly on the commercial real estate side, and to some degree on the residential real estate side. I wouldn't call myself a deep dive expert in those. And so those types of interviews you definitely want to prep for, and it's not appropriate—or I think beneficial to the listener—to just wing it. But you and I, when we have these conversations, we're just talking about what we both live, eat, and breathe every day. And it's nice to your point, Kathy, to have that sort of open timeframe. We try not to make these so short that they're of no value or so long that we start to hear the snores in the background. But we are not constrained, and there are times where we spend a bit more time diving into topics and other times where—it doesn't seem like a lot of times—where there's not much to talk about. But it's been a blast. We both talk for a living to a large degree, but it's nice to have a different kind of forum for doing that.

KATHY: So Liz Ann, that kind of reminds me of our first episode where we discussed a little bit about our own philosophy about analyzing the markets. And one of the things we discussed is how much we both read and where we get our information. And let's just follow up on that. Has anything changed in the past year for you in terms of how you work or sources that you're following? Is it pretty much the same as it has been?

LIZ ANN: You know, a lot of the same, but even in some of the sources of information, the type of data and research that is of greater interest to me has adjusted over time. I will say a lot of the focus for me in the first half of the year was diving into the history of concentrated markets and harkening back to the period like the late 1990s to glean what the similarities and differences were the last time we had that kind of concentration. So a lot of those research providers that we use that have enviable databases of historical information—we had Paul Hickey on from Bespoke—their database is extraordinary, and going back, SentimenTrader, the same thing in terms of not just sentiment-based data historically, but just reams of data on market behavior, and they are second-to-none in terms of what they have, especially in a period like the late 1990s as a comparison. 

Diving a bit more into Fed commentary, as I know you do, whether it's minutes or regional Fed updates, because of this unique cycle and having gone from the most aggressive tightening campaign to then a fairly lengthy pause period, during which the equity market had the best performance in the history of the pause period, to now this uncertainty with regard to rate cuts so a bit more inflation Fed-related research is resonating in this kind of backdrop and then a bit more information that we get both externally, and kudos to our colleagues at Schwab Equity Ratings because, as you know, Kathy, we've been very factor-focused in how we talk to our investors on the equity side of the equation. "Factors" is just another really word for characteristics. Instead of thinking in monolithic terms around large cap or small cap or growth-versus-value or individual sectors, we've had an emphasis on investing based on factors or characteristics, high-quality factors, focusing on companies with profitability profiles and strong balance sheets and strong free cash flow.

So a lot of work in the last couple of years and a lot of research from both our internal sources as well as external sources that is factor-oriented has been very additive into our mix. How about you?

KATHY: You know, I think in the past year, I mean, my philosophy hasn't really changed. I try really hard, and our team tries really hard to be open-minded about what's going to happen in the markets, not come in with a bias. It's hard not to, but we try very hard, and we check each other on that to make sure that we're being honest about where we're coming from, but also fact-based. 

And one of the things that I have experienced, I think, in this past year and in this cycle in particular is kind of bursting the bubble on a lot of the things that a lot of people held to be absolutely true to explain market movements. And when you do the math, you try to run a correlation or show some relationship between these two things that people are absolutely trying to convince you are related. And although intuitively it might be a good story, when you look at the data, it doesn't turn out to be the case. And that's one of the things that I think this past cycle and this past year has really been occupying a lot of my time. A lot of my time has been people sending me charts or forwarding things and saying, "OK, well, this is really interesting. Let's take a look at that. Let's dive into that." And then, with Collin and Cooper, we dive in, and a good amount of time we're seeing that it doesn't really pan out the way it's conveyed. And so I think if there's any value add to what we've been doing is we've had to really rethink a lot of things. It made us revisit a lot of what we held to be true to make sure that it actually stands up. And it's been a good exercise.

It's been good. It's been good. It's made us think more deeply. It's made us research more deeply. And there's some terrific people doing great work out there. I sat through two days online meeting of the Cleveland Fed on the topic of inflation. And a lot of great papers were presented, a lot of terrific speakers, many points of view on it. And what's interesting is I don't think I would have done that five years ago because it wasn't as hot a topic, and it wasn't as much up in the air as to what causes inflation or what inflation was doing. So people are really thinking very deeply about lot of topics, and not everybody's just throwing a chart together. You got a lot of really smart people doing a lot of really hard work, and that's been, for me, that's been very satisfying this year to see people tackle problems and rethink everything. I think that that's been a good thing on balance.

LIZ ANN: You know what I just realized I don't think I've asked you in the past year is, are you an avid podcast listener? And aside from a little podcast called On Investing that I'm sure you love, and it's at the top of your list. Do you listen to podcasts, and do you have favorites?

KATHY: I listen to a handful. I can't say that I'm a big podcast person because I don't drive much, so it's not like an opportunity in the car. I don't have a dog, so I'm not walking the dog and listening to a podcast. And when I'm at the gym, I kind of … or I'm out exercising outdoors, which I prefer, I try not to have anything in my ears so that I can enjoy the outdoors.

But I do of course listen to WashingtonWise with Mike Townsend because it's fantastic. I listen to the Financial Decoder with Mark Riepe because it's really, really interesting. And then a handful of others. I'm not, I have to admit, one reason I was scared to do this is I'm not a huge podcast person. So it took me a while to learn the value. How about you?

LIZ ANN: Well, I guess if it's a weekend, and I'm looking for something more fun and light, I think it's the number one podcast out there, but SmartLess, I think, is just fun and funny. But of the business variety, yeah, I'll also plug our colleagues Mike and Mark with their podcasts, which are fantastic. I really like Grant Williams, who writes a well-read newsletter called Things That Make You Go Hmm. And he has a series of podcasts, and they're really interesting. They're pretty long form. They can run over an hour. Pick your topics. There are some that are not as relevant or interesting, but macro and geopolitics and Fed and markets. So that, I would say his series of podcasts are go-to's if I'm not purposely geared toward one particular one or an episode to just sort of scroll through, "Who have been interesting guests?" That's one of the places that I will go.

KATHY: You know, this has been fun to reminisce, but now we've got to look forward. We got a lot going on. It's a busy week coming up, so what are you watching? We have a lot of data, we have elections, we have a Fed meeting. I assume you're watching all of that, but what do you think stands out? 

LIZ ANN: Yeah, and we're taping this earlier in the week. So just this week before the episode airs, we've got the PCE version of inflation, Personal Consumption Expenditures price index, and that's the Fed's preferred measure. We've got the big monthly jobs report at the end of next week. Actually, next week, to your point, we've got an election. We've got the Fed meeting. We get other data that is important, particularly ISM manufacturing and services. Those are Purchasing Managers Index, and they can sometimes provide pretty significant tidbits on the breakdown between what's going on in the services and the manufacturing side of the economy. We've got some consumer sentiment data, which includes inflation expectations, but I think jobs, the election, and the Fed meeting are probably top of mind. I assume so for you, as well, Kathy?

KATHY: Yeah, I think more than anything, there's a lot of question marks around all of those. So the jobs data skewed by the hurricane and the Boeing strike, so it'll be hard to get a kind of clean read on that. The Fed, I think there's a chance for a pause. I'm going to give it the same odds as the presidential election, 50-50. Seems like a tossup. We had seven members of the Fed at the last meeting who wanted to go 25. They eventually went 50 and agreed to that, but you could see from the dot plot that they were not totally enthusiastic about that. So we can make the case that maybe they pause, particularly without clean data, and just wait and see what happens till the December meeting, or they go another 25 and they wait in December, depending on how the data turn out. I think it's a tossup. I really don't have a feel for it. Maybe we'll get some hints from Fed speeches, but as we now enter the quiet period, we haven't had any hints either way. So obviously, that's big issue. 

And then, you know, with the election, I don't think we'll know anything definitive that quickly next week, but that's going to have an influence on sentiment and what people think is going to happen going forward, and that can affect the markets. Whether or not it actually does affect the markets is another question, but that's something we'll have to keep an eye on. I'm expecting a lot of volatility. I default to that—just expect a lot of volatility over the next week to 10 days or so.

LIZ ANN: That's it for us this week. This was fun. And thank you to everyone who has listened to the show so far. We continue to receive a lot of really great feedback for which we're so grateful. And it really does help, as well, when you leave a rating or review on Apple Podcasts. We are so grateful for this past year, in addition to what I hope is a continued interest in the podcast. You can also keep up with us in real time on social media. I'm @LizAnnSonders on X and LinkedIn. My normal PSA: I'm not on Facebook. I'm not on Instagram or WhatsApp. If you see someone claiming to be me, it's an imposter.

Also, if you want to find any of our articles, written reports, videos, please check them out on schwab.com/learn. And those are all publicly accessible. You don't need to be a client. You don't have to have a login to view them.

KATHY: And I'm @KathyJones—that's Kathy with a K—on X and LinkedIn. And as Liz Ann mentioned, if you've enjoyed the show, we really do appreciate those reviews on Apple Podcasts or rating on Spotify or feedback wherever you listen. You can also follow us for free in your favorite podcasting app. We'll be back with another episode next week, so stay tuned.

For important disclosures, see the show notes or schwab.com/OnInvesting.