MARK RIEPE:  Welcome to Schwab Market Talk, and thanks for your time today. The date is December 12^th, 2023. 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. I’m Mark Riepe and I head up to Schwab Center for Financial Research, and I’ll be your moderator today. 

We do these events once a month, but today we have a slightly different format. Each of our panelists will be speaking for about 10 minutes or so, using slides, and then when all four of them are finished, then we’ll start answering questions. So if you submitted questions when you’re registered, thank you. I’ve got those all printed out right here. For those who want to submit a live question, you can just type your question in at any time during the webcast, and then type it into the Q&A box, click Submit and we’ll take a look at those. And also these calls are normally every 60 minutes, but today we’ll be doing 75 minutes, so we can get to more questions. As for continuing education credits, live attendance at today’s webcast qualifies for one hour of CFP and/or CIMA continuing education credit. That means if you watch the replay, you won’t be eligible for any CE credit. In addition, if you want to qualify for credit, you’ve got to watch for a minimum of 50 minutes. To get CFP credit, please make sure you enter your CFP ID number in the window that should be popping up on your screen right now. It looks like it’s in the lower right-hand corner. In case you don’t see that, don’t worry, you should see it again at the end of the webcast, and then Schwab will be submitting that credit on your behalf to the CFP Board. For CIMA credit, you’re going to have to submit that on your own. Directions for submitting it can be found in the CIMA widget at the bottom of your screen. Finally, as I mentioned before, the speakers will be using slides today, and those slides are available for download via the Resources widget. And our speakers are Liz Ann Sonders, our Chief Investment Strategist; Jeffrey Kleintop, our Chief Global Strategist; Kathy Jones, our Chief Fixed Income Strategist; and Mike Townsend, he’s our managing Director of Legislative and Regulatory Affairs. And that’s also the order in which they’ll be speaking. So we’re going to start with Liz Ann, and she’s going to hand it over to Jeff, he will hand it over to Kathy, and then to Mike. 

So with that, Liz Ann, I think I’m going to hand it to you, so take it away. 

LIZ ANN SONDERS:  Great. Thanks, Mark. And hi, everybody. Welcome, and happy holidays, maybe most important. 

So this is a subset of visuals, some of which have been updated since the written report was published, but it’s not all of them. So as Mark suggested, take a look at all of our written reports because they provide a lot more information than what you’ll get in this brief update, but this is a high-level snapshot. So as many viewers know, because we certainly talked about it on these webcasts in the past, we’ve taken a more nuanced approach to defining this cycle using the terminology of rolling recessions, given that that’s actually what has occurred across a pretty wide swath of economic sectors. And that’s just the nature of the pandemic. We had such a burst of growth come during the stimulus era, but that growth was concentrated on the goods side of the economy. That’s also where the inflation problem began. So from left to right, we show some of these compressions in areas of the economy and the extent of the compressions, and it goes from left to right, the order of when they topped out and went into recession-like decline. So you’ve got housing here; ISM Manufacturing, both new orders, as well as the overall reading; as a proxy for earnings and consumption, you’ve got CEO Confidence, Consumer Confidence; and even services has not been immune, it’s just had a much milder decline. And we think the best case scenario looking into 2024 is not really a soft landing in a traditional sense because that ship has already sailed for areas like housing and manufacturing, housing-related, a lot of consumer products, but that if and when services gets hit and, you know, maybe helps to worsen the labor market because services is a larger employer, that maybe you’ve got some stabilization or even recovery in some of those areas. I don’t know if I would put a, you know, hundred percent likelihood on that, but that’s the way we think of best-case scenario. 

Another thing we did in the outlook was take a look at several sort of indexes or situations that occur in the economy, and look at whether we’re past the expiration date in terms of the signal that they provided. One of them is the LEI, the Leading Economic Index. You know, most people on this call are very familiar with it. You can see it on the left-hand side. That’s just the level. We’re now at 19 consecutive months of decline. I think the next reading comes out in a day or two, so that will be updated. And you can see if you look at those light-blue recession bars that this kind of decline has only been seen historically in recessions. But what we did with the table on the right, and I’m going to have to lean in although I don’t need to cite all the numbers, is we took a look at prior peaks in the LAI in the history of the Conference Board, putting out this index on a monthly basis. Then when the recession began, which we only know after the fact of course per the NBER declaration, and then the number of months. And you can see the average is 11, the median is 10, but you have an incredibly wide range historically from as little as a three-month gap between the two and as many as, I think, 21 months’ gap between the two. So be careful when you have somebody say the typical or the average because the range is very wide, and that certainly applies for market performance during those various spans of time too. Kind of an ‘meh’ average, but a pretty significant range. And it was the first set of data points that we showed in the outlook, where we put in the admonition of analysis of, you know, analysis of an average can lead to average analysis, and that applies with leading indicators. 

Same thing, quite frankly, with the inversion of the yield curve. You can see that here. Again, the light-blue bars are recession bars. The points that are colored red is when the yield curve was inverted. And with the exception of a very, very brief and very mild inversion in 1998, you can barely see it, it looks like one little red dot, the yield curve has been… let’s call it a perfect, you know, predictor of recessions. But again, the lag time is very variable as you can see on the right-hand side, with an average of 13 months, but a pretty wide range around that. And same thing with the S&P performance, a very wide range for an otherwise ‘meh’ kind of average. 

So we remind again that, you know, analysis of an average leads to average analysis. And it’s just another way to point out there’s so many other forces that influence the market. We shouldn’t look at any of these data points, especially with averages, as anything akin to gospel in terms of market performance. 

The last one we did with the same type of analysis is the final rate hike, and we do believe that the July hike was probably the final one in this cycle, barring, you know, a surprise big, you know, shot back up in inflation. And as recently as just yesterday, I saw a headline saying, ‘Well, the typical market behavior once the Fed is finished hiking is…’ And I thought, boy, again, here you’ve got a small sample size, you’ve got a very, very wide range, and there are so many other forces that influence markets. So just the fact that the Fed seems to be done isn’t some perfect historical indicator of what the market is going to do. If you look at the table, you know, six months after final rate hikes, historically, the range of performance is from negative 18 to plus 20. If you go a year out, the range is negative 30 to plus 30. 

And I also just added a column to this that isn’t in here because we had already put this through compliance that covering the pause period, which is that final column, the number of days between the final rate hike and the first rate cut, and FYI, the range goes from negative 28% to positive 28%. So, again, analysis of an average leads to average analysis.

You can see the darker blue line there, that is the current path for the market. And as you can see, since July, the path has been below, kind of in that red zone of the range, but has recently popped back up. I happen to think that what is probably going to be a bigger driver of Fed policy next year, meaning the point at which they start cutting how aggressive they need to be, brings the labor market much more into the picture, whereas their tightening cycle is very much keyed-off just the inflation half of their dual mandate. I think the labor market half of their dual mandate is probably going to be a more significant driver, and absent more deterioration there, we do think that the expectations of a cut starting as soon as March may be a bit premature.

Tying it into the equity market, obviously this is a higher yield environment… although in the case of the 10-year has come down from 5% recently, and that sat behind the rally in the stock market, given that the stock market is very much keying off of what’s going on in the bond market. But importantly, if you look on a rolling one-year basis, this is the correlation between the S&P 500 and the 10-year treasury yield. So a lot of correlation analysis is done on, you know, stock prices versus bond prices. This is yields versus stock prices, and I think it’s sometimes easier to understand that way. And what you can see is about a 25-year period or so that’s mostly colored green here, that’s the great moderation era, where bond yields and stock prices were positively correlated, because that was an era, for the most part of disinflation. So in that era when yields were rising, stocks were often rising too because rising yields was more a signal about better growth without the attendant significant concern about inflation. That was not the case, as you can see in the 30 years or so prior to the great moderation from the mid-60s to the mid-90s where almost the entire period of time you had a negative correlation, and that was because it was more of an inflationary backdrop. And one of our longer term themes has been around the end of the great moderation and the likelihood we’re not going back. 

Getting to a more micro level in terms of how things like moves in yields impact the stock market, it is maybe somewhat obvious, but this is the 10-year treasury yield, the lighter line, and then you’ve got the S&P 500, so it’s just the S&P 500 in this here, the average effective interest rate. And there’s much more variability and volatility, obviously, in the 10-year yield, but generally they’re moving in the same direction. And that more than suggests that pressure on companies in terms of interest expense is going up. There are plenty of companies that are perfectly capable of handling that. I think that’s some of the reason for what until recently was a large-cap bias in the market, but it’s really going to put some pressure on zombie-type companies, which are not generally in the S&P 500. 

In terms of the implications for earnings growth, it’s been an interesting cycle for lots of reasons, but one of which is the fact that analysts are kind of changing estimates in much nearer-term fashion. They sort of go through earning season, they’ve already made their adjustment to that quarter, and maybe they’ll adjust to the next quarter, but they’re not doing a heck of a lot with forward estimates. Here you see on the dark-blue is the S&P 500. The lighter blue is a Russell 2000, the estimated growth rate. I think one of the reasons why small-caps have picked up some traction in the last month is, as you can see, the expected swing factor is quite significant for the Russell relative to the S&P 500, where if consensus is correct, and I think consensus may still be a little too lofty, you go from a negative 11% to a plus 30%. And I think that has been one of the props for smaller-cap stocks recently. And of course it’s helped to ease valuation a little bit. You’ve seen the forward PE now fall a bit for the S&P now that you’ve got earnings looking to accelerate. Again, same with the Russell. But here’s sort of a position that we’ve been recommending, which is if you want to move down the cap spectrum and look for ideas, be careful about the Russell 2000 because it’s still filled with a lot of zombie companies. The S&P 600 as just a base has a quality and profitability filter, and as a result of having more profitable companies, you actually see a much more reasonable multiple. So we think there’s opportunities in smaller-cap names than just the, you know, Magnificent Seven, but we still think you want to stay up in quality in part because of what we show here. The Russell 2000, even though it’s come down, still has more than 30% of zombie companies. So you still want to stay up in quality even if we think there are opportunities presenting themselves kind of down the cap spectrum. 

So just a couple of takeaways to summarize what we’re talking about. Unique cycle here. Rolling recessions could turn into rolling recoveries. I still think an actual recession should be on the table because we’re not past the expiration date of a variety of metrics. We do think the Fed is probably done hiking, but there is a big difference between a pause and a pivot. Also think we’re not heading back to the great moderation, but have some volatility along this transition. Again, stay up in quality, and always stick with the disciplines around diversification and rebalancing. 

So we’re supposed to show the disclosures for a couple of seconds. There’s page one. There’s page two. While you take time to read it, I am going to take this moment to turn it over to my colleague, Jeff, so he can take us around the world. 

JEFF KLEINTOP:  Thanks, Liz Ann. You know, Liz Ann did a nice job of curating the charts that are in her full outlook for you today on this broadcast. I did not do that. I threw all my charts in. So there’s some I’m not going to get a lot of time to speak about, but consider it a preview of what you’ll find in the full outlook for you to look that up and check it out. So I’ll be going through a summary of these things.

Now, it was a bit of a challenge for me to write the 2024 Global Outlook. You know, I think we’re accustomed to defining investment environments in terms of calendar years, but I’m not so sure that 2024 fits the bill very well. It may be a turn in earnings growth and in policy rates, but that may not be easy to identify in real time. I think investors are going to have to step back a little bit and see the bigger picture and look beyond what I think is going to be a lot of noise and volatility. And I’m reminded of, sort of reminiscent of this cartoon here, that scene in Ferris Bueller’s Day off, a great movie, where Ferris’s friend, Cameron, was focusing more and more closely at a child in one of Seurat’s paintings when they take that trip to the museum. In the commentary on the DVD, John Hughes said, ‘The closer Cameron looks at the child, the less he sees.’ And, you know, the face kind of just disintegrates into a jumble of chaotic, pointless dots, as he gets closer and closer. And I think that’s going to be true for 2024. The closer we get to something, the more complicated and noisy and chaotic it can seem. Focusing too closely or too near-term on the economy, or markets, or even politics in 2024, can risk missing the bigger picture and the broader trend, I think.

Now, the bigger picture that we see for 2024 for the globe is of a shallow… I guess I’d have to call it like a U-shaped recovery in global economic and earnings growth, rather than the V-shape that we’ve been accustomed to in recent economic downturns. If the global economy experience something like a soft landing in 2023, with growth for nearly all the G-7 countries stalling but not contracting very much, then it’s also likely a soft recovery that gets slowly underway during 2024, with growth rebounding only modestly and unevenly throughout the year. Global stocks may, therefore, react to that with heightened volatility, right? A lot of noise, some chaos, all these seemingly chaotic data points, as parts of the global economy are going to move in different directions. I’ll talk a bit about that, and I think the broader stabilization and recovery might only be visible over time. Again, the day to day, the week to week, even the month to month data could be pretty noisy. 

Can Taylor Swift save 2024? That’s the question we need to ask ourselves. Time Magazine’s Person of The Year is also the economy’s most valuable person of the year. I’ve described this year as a cardboard box recession due to the downturn concentrated in manufacturing and trade, things that go in a box, but I could just as easily have… whoops, I’m trying to advance the slide and it’s not working. There we go. Sorry, let me start again. I called it a cardboard box recession because the slowdown in manufacturing and trade, right, stuff that goes in a box, but I could have just as easily called it a Taylor Swift expansion. There’s been an amazing and unusual divergence between weak manufacturing activity, measured by demand for cardboard boxes for one thing, and live concerts, as Swifties know. But after a booming summer for entertainment and travel around the world… I’d note that Japan saw the biggest influx of tourists it’s ever seen, in terms of revenue they generated and number of people. So it wasn’t just US, it was really around the world, travel, entertainment boomed, and that helped to boom services, and what you saw was a slump in factory output. That now seems to be converging as we head towards 2024. So maybe we see a cardboard box recession turn into a cardboard box recovery next year, and maybe that post lockdown travel and entertainment boom has finally run its course. 

This chart you’re looking at here, you know, we could measure the manufacturing, the cardboard box recession, in a number of different ways— falling factory output, trade volumes. I like to look at the PMI. So the November reading for the Global Manufacturing PMI marked the 15^th  month in a row below 50. And so you can see here that ties the longest stretch in history that ended two decades ago, back in 2002. Now, the downturn is nowhere deep as most of those past manufacturing downturns, but it has extended in duration, so it’s kind of a recession in time, if not in depth, when it comes to manufacturing. 

Looking forward, new orders still look pretty soft. So I think in the early months of 2024, we may still see some weakness in manufacturing before that begins to firm up, as inventories are drawn down and demand stabilizes. So, you know, we may see manufacturing begin to pick back up again. So the cardboard box recovery taking root, at the same time, maybe the Taylor Swift boom slows down a little bit. 

Economies around the world more exposed to manufacturing and trade have been among the weakest. Germany is the poster child of this, all about trade and manufacturing. That economy has contracted in four of the past six quarters and three of the four this year. Economies, though, that are more service- focused, like France, you know, so like the US, they fared better. France has, in fact, only seen one negative GDP growth quarter during the past six. 

So I think this modest cardboard box kind of recovery… here’s the table, by the way, of growth and contraction across these G-7 economies. So if we get this cardboard box recovery, manufacturing growth may accelerate, although probably still remain below average, while service-based economies may decelerate a little bit. In fact, the OECD came out with their forecasts across countries, I think it was last week, or maybe the week before, and exactly that, seeing Germany recover from recession, but France slow down a little bit. So these are echoed in what we’re seeing across countries. And the service sector has slowed down. The latest reading for the services PMI was 50.6 in November, down from its peak of 55.3 back in April. 

So that’s the global economic backdrop. 

Now, what about rates? So I think it would be too easy to call 2023 a year of rate hikes and 2024 a year of rate cuts. And this is just a chart of the outlook for rates, when you look at the futures market, where they see rates headed across these different countries. I think that overstates the changing conditions. Policy rates are probably at a peak in most economies, but we don’t expect them to fall rapidly. The interest rate futures market you can see here is not showing anything like an upside-down V, more of a long, slow decline, maybe like an upside-down U shape, I don’t know what you call that shape. Also, quantitative tightening continues, as does the lagged impact of all the rate hikes that have been in place so far, combined with, you know, climbing bankruptcies and weaker job outlook. So I think what stands out to me on this chart is maybe not a whole lot of easing, that you could call this a big year of cuts. Yeah, there will be cuts, but maybe not to the same degree we saw hikes. 

The other factor I think is important on here is the red line on the bottom of the chart. That’s the outlier. That’s the Bank of Japan. Decades of current account surpluses have accumulated for Japan, and giving them the world’s largest net international investment position, even more than China. Let me show you what this looks like. Check this out. So this is sort of the net, if you will, of investment into a country versus out. And what you see here is, you know, on the bottom there, that’s the US. Of course, the rest of the world invests heavily in the US, so the US is a negative net investment position. Japan is the biggest, the largest around the world. 3.3 trillion in assets of Chinese… sorry, Japanese investors are invested outside Japan. And should the BOJ begin to substantially tighten monetary policy next year, and there’s even some rumor they could do so December 19^th, at their next meeting, there’s a potential for reversal of decades of outward flow of capital, which can be felt by investors worldwide as that money gets repatriated back to Japan. I wrote a lot about this over the course of the year, beginning back in February, but most recently, just a month or so ago. You may want to check that on schwab.com, really diving into what would this mean, how would markets move in response to this? 

So let me sum up. I think as the global economy transitions to a new cycle, markets are experiencing new leadership. We forecast that European stocks would lead US stocks in 2023. And they did, the STOXX 50 Index did outperform the S&P 500 Index, measured in dollars or in euros, but only barely. We had really strong performance by the US’s Magnificent Seven, and that made the gap very narrow. In fact, basically they were in line. But on an equal-weighted basis, their performance was quite different. 

Let me show you the chart here. So this is just looking at year-to-date performance here of equal-weighted indexes. So in 2023, the average international stock outpaced the average US stock. Few people know this. The MSCI EAFI equal-weighted index outperformed the S&P 500 equal-weighted index by nearly 5% this year, adding to the 15 percentage points of outperformance that we’ve seen since the bear market ended back in October of 2021. 

I think this could continue next year. Global economic and earnings growth may be sluggish for much of next year, and that can mean stock prices are more determined by moves in the price-to-earnings ratio than earnings themselves, as investors trying to figure out what the right valuation multiple is in an environment of higher discount rates, and uncertainty over the timing and pace of an earnings rebound. International stock valuations are already braced for a challenging 2024. You know, investor sentiment surveys in Europe are not far from decade lows, and the price-to-earnings ratio for the EAFE Index is 15% below its 10-year average. Many Japanese stocks have price-to-book ratios below one, very cheap stock. So I think there’s more room to outperform there. And valuations could lift on clarity around rate cuts and as the manufacturing backdrop firms up later in the year, I’d point out that both Japan and Germany, very manufacturing focused. If that looks a little bit better, a brighter outlook there could further this outperformance we’ve seen.

On the emerging market side, I’m still not excited about emerging markets. I think it’s all going to revolve around China and India. They make up 40% of EM Index. There are… some of the reasons that have prompt concern around investing in China this year may be improving. Property markets seems to be stabilized, and watch those home prices in China very carefully. That seems to be doing better. The latest meetings in the last couple of weeks indicated there’s probably more stimulus coming to support the housing market. But there’s still a great property market overhang weighing on consumer spending there. You just can’t get real excited about it until they see more clarity around all of that. 

On the flip side, India’s growth is absolutely booming, 7.6% growth in the third quarter. Incredible. They’re probably at least at 6-, maybe 7% growth in each of the next couple of years. But that’s not a surprise to investors in Indian inequities. The PEs are quite high. So India has to keep exceeding expectations to sustain these multiples. I think they might do that, but there is some risk around it. So it’s not as easy as a decision like go with India over China as it may seem, given the huge gap in valuations between stocks of the two countries. 

So summing it all up, for investors in 2024, I think what might seem like chaotic data points, as services slump a little bit, manufacturing comes back, different countries moving in different directions, on a day-to-day basis, I think you can see a lot of volatility. But over the course of the year, I think you see a clearer and bigger picture view of a new multi-year cycle beginning to unfold, and along with that, outperformance of international equities for another year. 

So I’ll wrap up there and give you a view of these disclosure slides, which you love, as I turn it over to Kathy Jones, for her fixed income memo.

KATHY JONES:  Froze up on... I hope you can. Thank you. Sorry about that Jeff. You froze up on me there for a second. 

I’m going to run through our outlook on fixed income markets for 2024. And as you know, we all choose our cartoons. Mine is depicting Fed Chair Powell trying to select an ice cream cone, which we’ve got the list there of very vanilla, and, you know, mellow mango, and soft-landing strawberry. But he can’t have any of those. You know, he can only have Rocky Road. And I think that the message here is that we are pretty optimistic about the outlook for returns in the fixed income market in 2024, but we do think it’s going to be a bit of a rocky road. And the primary reason for that is the Fed’s reaction function, which is different today than it has been in the past. So it’s more backward-looking than forward-looking. Throughout this cycle, the Fed has been trying to catch up with the changes in what’s going on in the economic data and inflation, and they’ve chosen to be more backward-looking and wait for inflation to come down, as opposed to being in the past cycles, more forward-looking and trying to anticipate where we’re going, and shift policy in advance of that. The difference here is the market, of course, is forward-looking, and if the Fed is backward-looking, you’re going to get a lot of these whipsaws I think, that we’ve seen in the last year or so. That will probably continue.

Just to set the stage, here’s 10-year treasury yields over the past year. And we came into the year at around 3.80, ran all the way up to 5% in late October/early November, and then we’ve come down a good 80 basis points from then. So it has been a rocky road already. We think the trajectory continues to move lower, and that we will see Fed rate cuts ahead, but not as early, probably, as the market is anticipating, and perhaps not as deep, simply because its reaction function is different.

Inflation, you know, the key driver behind Fed policy and behind bond yields is inflation, and inflation has been falling. We’ve had some good CPI numbers today. This is the PCE and Core PCE. You can see they’re both edging lower. And I would argue there’s been a lot of talk about sticky inflation, but we’re not seeing that. We’re seeing […audio dropout…] on the downside, still this own equivalent rent… we know in real life rents are falling, but they’re not showing up in the numbers. That’s still to come. But all in all, still a positive trend in terms of inflation. We think that that continues to be supportive to the bond market, not just domestically but globally. We do look for rate cuts around the world to help reinforce this. This is a more synchronized cycle now, with the exception, as Jeff mentioned, of Japan. 

So the key question, and I think this will come up at the press conference that the Fed holds tomorrow, is policy restrictive enough for the Fed to stop raising rates here and to start cutting as inflation falls? We think it is. We think the evidence is not to look at the financial conditions indices that are so popular. Those do indicate that in the capital markets conditions have eased because the stock market has gone up and credit spreads have narrowed, but when you look at real financing costs, they’re high. Real rates, the highest they’ve been since 2008, pretty much across the board. That should be high enough to result in slower economic growth and restrain pricing power among companies that are finding it more expensive to borrow. And in the corporate bond world, we’re certainly seeing the lower tranches of the […audio dropout…] pull inflation down, and there’s room for real rates to come down. 

As I mentioned, bank lending standards have tightened. They ease up just a little bit in the last quarter, but they’re clearly in very restrictive territory. Now, not all financing these days goes through the banking channel, but it’s certainly still significant. Also seeing some more difficulty in the private sector, private credit markets, with financing, and that, too, should be a restraint on economic growth. 

And then there’s quantitative tightening. The Fed is still tightening. Balance sheet is down about a trillion, overall, from the peak. We expect that trend to continue. That’s what the Fed has communicated to us, that they will continue to tighten through quantitative tightening, even when they’ve shifted to cuts in rates, which is kind of an unusual policy. But nonetheless, the Fed is very eager to get its balance sheet down to something closer to pre-pandemic levels, and that means that barring some sort of a pinch point or problem in the financing markets, they will likely continue to tighten even after they’re shifting to reducing rates. So that means overall conditions still restrictive and tightening. 

So the one way to kind of measure is Fed policy tight enough, San Francisco Fed has this proxy Fed Funds Rate, the effective rate. If you were to combine rate hikes, quantitative tightening, and forward guidance, which is higher for longer, this is approximately where Fed policy would be if it were just going through the rate hike channel, the Fed Funds channel. You can see well over 6%, about 6-1/2%  equivalent. So, again, a pretty high number, one of the highest number we’ve had in terms of Fed policy for a very long time. So I would argue, yes, policy is restrictive enough, it’s taking its time to work its way through the cycle, but nonetheless the Fed really doesn’t have to do more. 

We do expect the Fed to begin cutting rates probably second half of the year, maybe around mid-year in the June meeting. We are only, though, penciling in three 25-basis-point rate cuts in 2024. And the reason is we’re respecting that forward guidance that we’re getting. We’re looking at what the Fed is telling us it intends to do. We’ll take a close look at the dot plot tomorrow to see, you know, the updated vision of that. But conservatively speaking, we’re penciling in three 25-basis-point rate cuts starting mid-year, and that we think will keep the yield curve inverted, and continue to weigh on economic growth and help pull down inflation. And, after all, that is what the Fed’s goal is right here. And they’re comfortable doing that because the unemployment rate is so low. They haven’t incurred the kind of pain in the economy that had been anticipated at this stage of the game. So the Fed can afford, I think, in its view, to continue this tight policy for a bit longer, until it really sees inflation heading towards that 2%. And by the way, you know, quick calculation on the CPI numbers today, if you look at core CPI, we could be at 2% by March or April of next year if the month-to-month increases continue to be very, very tame. That’s a big question mark, but the goal is not that far away and that’s why we’re optimistic about yields continuing to come down. 

So given the uncertainty, though, about, you know, the market is pricing in right now about four quarter point cuts, again, about 110 basis points as of this morning in Fed rate cuts priced in for 2024, giving the ending Fed Funds Rate, you know, right around 4.22 is the number that’s popping up on my screen, and that would be starting about March. It’s a bit more aggressive than we would be because we think the Fed wants to be more in a reaction mode this time around. So given that, we decided to look at just scenarios, given that there’s still a lot of uncertainty. We do think it’s going to be a rocky road because of the uncertainty about the timing and magnitude and pace of Fed rate cuts, and rate cuts around the world as well. 

So what we’ve got here is a baseline scenario. So our baseline scenario says we expect three cuts, and then… starting in mid 2024. And you can see from… so we have the yield curve as of about a week ago, is the dark-blue line, and then the baseline scenario is the lighter-blue line. So what we have is the curve coming down, flattening out, and starting to actually revert back to re-steepen, but at lower yields. Then we looked at, okay, well, the scenario… you know, alternative scenario number one is inflation reignites, the Fed has to hike more aggressively. And then what does that look like? Well, we think what that does is just deepen the yield curve inversion some more, and you get higher short-term rates, and the 10-year actually ending the year right about where it is today, but a deeper inversion of the yield curve. And then the alternative scenario number two is on the opposite side, and that’s a recession scenario, where the Fed has to cut much more aggressively and get the economy going again. And that you can see is the dark-blue line, where yields fall across the curve, the curve begins to normalize somewhat, re-steepen somewhat as time goes by, but you end up in the threes. So these are our three scenarios. 

Then we said, ‘Okay, well what happens over… what’s a one-year estimated holding period for the Ag… I’m sorry, for ladders and barbells in treasuries, commonly used strategies, under these three scenarios? So what would your total return be in the baseline, in scenario one where inflation picks up again, scenario two in a recession? And you can see the results here for the one- to-five-year barbell, for the 10-year barbell, one- to five-year ladder, one- to 10-year ladder. So we know that these are things that advisors frequently… strategies advisors frequently use for clients. You can see in all cases, if we’re right about this, you actually have positive returns, and that’s because we’re starting at much higher yields than we’ve had for so long, and that coupon income is such a huge component of the total return. Under the baseline scenario, you know, you get a pretty good return of 5-, 5-1/2-, to maybe 6%, depending on how much credit risk you might want to throw in there. But that’s a baseline scenario, where you only get three Fed rate cuts, but you do continue to see inflation come down and yields drift somewhat lower from here. And that’s reflecting basically the starting yield. So you’re going to start at 5-, 5-1/2, you’re going to end with 5-, 5-1/2 total return. But with barbells and ladders, you sort of spread out the… you reduce the volatility presumably because of the strategy. Even in the inflation reignites scenario, positive return because you’re starting with higher coupon, offsetting some of the potential price decline. And clearly the one- to 10-year gives you the best return. And then scenario two, a recession scenario, you get, you know, pretty positive returns because rates would fall the most in magnitude and most rapidly. 

So we’re optimistic about returns based on the starting yield, the scenario that we’re looking at, slowing economy, some version of Fed rate cuts. We think that that continues to bring yields down and deliver positive returns. We do think it’s going to be a bumpy ride. I think we’ll have this pattern where the market gets ahead of the Fed and then has to back up, and gets ahead of the Fed and has to back up again. That’s probably the pattern we’re looking at, and that’s why we would suggest a barbell or ladder strategy because you’re going to smooth out some of those ups and downs. 

I’ll just quickly touch on credit and municipal bonds. On the credit outlook, you know, we’re still neutral, somewhat cautious on lower credit quality, particularly high-yield and bank loans. Those have done extremely well this year. So far, it had a great year because credit spreads have actually compressed in a very unusual pattern for when the Fed is hiking rates. But we’ve had this sort of soft-landing scenario, and a lot of companies that are in that lower credit quality category have been able to refinance or term-out their debt, the maturity of their debt, so that they haven’t faced it. But we do see maturity wall approaching. A lot of what we’ve also seen is distressed debt exchanges taking some of the defaults out of the indices, and that may be a pattern that continues, but we’d still be somewhat cautious there. 

Municipal bonds, you know, outlook is generally in line with treasuries. Credit quality is still good, municipality is still in good shape. Returns, particularly for people in high tax bracket, still look attractive. 

And with that I’ll show you some disclosures, and gradually turn it over to my friend and colleague, Mike Townsend, for his outlook on what’s going on in Washington. 

MIKE TOWNSEND:  Well, thank you Kathy. And hello, everybody, from sunny and chilly, Washington. I don’t have a fun cartoon to start my presentation, but if I did, it would probably look something like the Titanic crashing into an iceberg because we’ve seen historic levels of dysfunction here in Washington, I think as everyone is aware, and unfortunately, I’m not sure that that’s going to really improve much in 2024. But I thought I’d just run through quickly some of the key issues that we’re going to be watching as we head into the new year. 

Congress is expected to wrap up this week, and I think will leave town without passing any emergency aid for Ukraine or Israel. They’re still very bogged down in border security negotiations, which have become connected to the Ukraine aid and the Israel aid package. And I don’t anticipate any dramatic change even with the Ukrainian President Zelensky here in Washington today to try to make his case. I just think time is probably going to run out before anything can happen. And that pushes that issue, along with so many other issues, into early 2024.

Probably topping the list as we begin the year in 2024, however, are the two, twin deadlines for a potential government shutdown. Congress has twice avoided a government shutdown this fall by kicking the can down the road. They have kind of an unusual setup here for the next government shutdown battle, with two deadlines. About 20% of government funding, five major agencies, are funded through January 19^th, with the rest of the government funded through February 2^nd. And in that kind of situation, you have a really unpredictable outcome as to how this might play-out because you have the potential for a partial shutdown of some of the government in mid-January, and then potentially a full shutdown if Congress can’t resolve things by early February. 

I do think there is a significant risk of a shutdown, given the dysfunction in Congress, given comments from the new Speaker of the House, Mike Johnson, that he would not pass another, you know, short-term, temporary extension of funding. So I think there’s very much a risk. But keep in mind that the market, historically, does not care that much about government shutdowns. Over all the shutdowns going back to the mid-70s, it’s pretty much a wash in terms of market performance. And, in fact, in the last five government shutdowns, the S&P 500 has actually gone up, which probably tells you all you need to know about how much the market cares about what’s going on in Washington, given that the market has gone up when Washington was literally closed. So I think that’s going to be a real potential for a shutdown, but probably not a big market-moving event. 

I do think length of a shutdown matters. So if you’re talking about a shutdown that goes three, four, five weeks, then you start to have some measurable economic impact that I think we’ll need to keep an eye on, and there may be a market reaction as that plays out. 

This debate, of course, is sort of a proxy for a larger battle over the budget deficit and the national debt. And the reason that’s come back into the central line of discussion is, of course, because of the higher interest rates. We’ve seen an enormous increase, an 87% increase in the amount that the US is paying to service the national debt over just two years ago, and that has attributable course to the increased interest rates. So that’s put this larger discussion about how to deal with the budget deficit, which is approaching $2 trillion, of course the national debt, which is now in the $33 trillion-plus range, that’s put that much more on the front burner. 

One thing to remember about the debt, however, is that the debt ceiling battle is off the table through 2024 and into 2025. The debt ceiling battle will come back in the next Congress in the first half of 2025.

A couple of other issues to watch that I would just keep my eye on in 2024, cryptocurrency. And the ongoing effort to try to create in Congress a better regulatory structure for cryptocurrency may get a boost in momentum, by the fact that House Financial Services Committee chairman, Patrick McHenry, the Republican from North Carolina, announced that he is not running for reelection. So he is going to serve for the next year as chair, and this is one of his priorities, is try to get to a regulatory structure for cryptocurrency that includes investor protections, and that’s going to be one of his goals, I think, of his final year in Congress. And often when you have a veteran member like Congressman McHenry heading towards retirement, it tends to, you know, make his colleagues maybe more favorable to try to get him something that he really would like to see before the end of his term. So that’s one to keep an eye on. 

And the other is artificial intelligence, where there’s clearly interest on Capitol Hill in a bipartisan fashion to try to put some parameters and guardrails around AI. I think that probably took on even more urgency with the fact that the European Union has made significant progress in putting their AI restrictions and structure in place. So that may also be an area of where you could see some actual movement on Capitol Hill in 2024. 

And then, finally, from a tax and retirement savings standpoint, I don’t expect 2024, presidential election year, to be a big year for tax issues, but, boy, does it set up a gigantic fight in 2025, because of course the 2017 tax cuts expire at the end of 2025. That includes not only the lower individual income tax rates, the corporate rate, higher standard deduction, but probably from a planning perspective, the most important one of course is the estate tax, which would see the exemption amount drop by about 50% if not extended at the end of 2025. This is going to be the number one issue on the plate for the new Congress once that’s selected next November when it takes office in early 2025. And so we will obviously be watching that. I don’t think we’ll have any way to really know how that’s going to play out until we see the election outcome, have a better idea of what the political alignment is going to be in Washington. 

I do think 2024 is going to be a busy regulatory year, particularly for a number of SEC initiatives that are in the queue and sort of lined up for finalization. 

Topping that list is the very controversial public company disclosure on climate risk proposal, which is in the queue for first quarter of 2024 approval. I do think if and when that gets approved by the SEC, it will be almost immediately challenged in court, and that’s how that issue will ultimately be decided. 

The series of proposals to overhaul equity market structure also in the queue for early 2024 approval. Also very controversial, a lot of pushback from the industry and from investors. So we’ll see how those final proposals change maybe from what’s been proposed so far. 

Mutual fund liquidity risk management, which is the proposal that includes the so-called hard 4:00 PM close for mutual funds that would, if passed and finalized, would probably result in mutual funds having to have an earlier cutoff time than market close. That’s also one that is in the queue. That one has been overshadowed a little bit by some of these others that I mentioned, and we don’t have as good a fix on the timing on that as some of these others. 

And then the one that has really, I think, drawn a lot of attention from the RIA industry is the SEC’s proposal around the use of predictive data analytics in advice interactions. A very, very broad proposal that would cover all kinds of use of technology when providing advice to an investor, but most notably would sort of change decades of policy around disclosure, and would require any conflicts to be not just disclosed but mitigated or eliminated, which, obviously, is a whole other level of complexity for businesses. 

So those are just some of the SEC ones to watch. 

They’re also a series of RIA-specific proposals in the queue, the expanded custody rule, cybersecurity risk management, and I would also put the oversight of third-party service providers, all of which are specific to investment advisors. Those are also all in the queue to be finalized in 2024. And there’s some urgency to do this because these all need to be finalized by around May of 2024 in order to potentially avoid Congressional Review Act processes, which would allow the new Congress to revisit them early in 2025 and potentially overturn them. So the SEC is going to be very, very busy. I think that’s definitely going to be something to watch for all advisors. 

And then, finally, no regulatory update would be complete for advisors without the reality that the Fiduciary Rule, now called the DOL Retirement Security Rule, is back for year 14 of its ongoing annual performance. And that comment period is coming to a close. And that’s another one that we expect could have significant impacts if it is finalized in 2024. 

So a lot of things in the regulatory queue. In some ways probably busier than the legislative queue in 2024, just given the divides and battling on Capitol Hill.

And then, of course, it’s an election year. You know, all signs certainly point to a presidential rematch, but I expect there’s going to be a lot of twists and turns. We have two candidates in President Biden and former President Trump, who have a lot of very obvious flaws. Former President Trump will be dealing with a number of legal issues, as we’re all aware. President Biden, whose popularity is very low and whose age is a big concern to lots of voters. So two flawed candidates heading towards a rematch. Hard to say, you know, whether anything will change. There’s certainly a lot of speculation that one or both will not be the nominee. I think that is very unlikely, but we’ll, again, have to see how all that plays out. 

The battle for control on Capitol Hill will be very, very interesting. The Senate is very, very close, as everyone knows, 51-49 right now, Democrats are defending 23 seats and Republicans just 11 next November. The 23 seats that the Democrats are defending include the three states where Democrats are representing Red states. That’s West Virginia, where moderate Senator Democrat, Joe Manchin, has already said he is not running for reelection, which probably all but guarantees that the West Virginia seat will flip to Republicans. Also, in Montana and Ohio, those are challenging races. Arizona is going to have a very interesting three-way battle, potentially, for that Senate seat. So there’s a number of opportunities I think, for Republicans to capture the additional seat or two that they need to get the majority. I would say they’re favored at this point. 

I do think on the other side of Capitol Hill that Democrats have a really good chance to flip the House. The Republicans have just a couple of seat majority right now. A number of those seats were highly contested in 2022, with seven Republicans winning with less than 1% of the vote. So I think all those are potential opportunities. There are also some changes that are going on in various states due to court requirements for redrawing of districts. So I don’t think it’s at all slam dunk for the Democrats, but I do think they probably have a slight advantage heading into 2024 to recapture the House. And that would certainly be interesting because that has never actually happened, where the House and Senate have flipped in opposite directions in the same election. 

So there are going to be a lot of things to watch as this campaign season unfolds. I think the campaign a year is going to be dominated by the presidential race, but in many ways, the battle for the House and Senate is probably more impactful to actual policy that could affect investors and the markets, even in the presidential race. 

So it should be an exciting year, as I will wrap up and show my little disclosure slides. And I think we now have some time for questions, so I’m going to ask Mark Riepe to rejoin us and facilitate a Q&A session. Thanks. 

MARK:  Thanks, Mike. Appreciate it. S

o Liz Ann, I’m going to start out with you for questions. We had multiple versions of people asking about value versus growth. So what are your thoughts on that? 

LIZ ANN:  So it depends on what is meant by value and growth. And I’ll expand on that, but I think this is really important, and there’s so many misperceptions out there. I think of value and growth, that there’s three ways to think about it. There is our preconceived notions of what might be value stocks and what might be growth stocks. Examples would be, you know, utilities as value stocks or tech as growth stocks. There’s a lot of validity to that. Then there are the actual characteristics, growth characteristics, value characteristics. And then there are the indexes labeled growth and value. And that’s where one might think there’s consistency, but it isn’t always the case. In fact, 2023 was a wild year on this subject. 

So S&P has four growth and value indexes. They call them S&P Growth, S&P Pure Growth, S&P Value, S&P Pure Value, and they divide the S&P 500 into those four. If you’re in either Pure Growth or Pure Value, you don’t overlap. If you’re in regular Growth, you can also be in regular Value. So they do their rebalancing in mid-December, there’s one coming up in a few days. But last year, on December 18^th, the day before the rebalancing, all eight of the Mega-Cap 8 stocks were in S&P Pure Growth, and technology was 37% of that index. On December 19th, the day of the rebalancing, only one of the eight was still in Pure Growth, and the other seven actually went into a combination of regular Growth and regular Value. Tech went from being 37% of the index to 13% of the index. Energy became the dominant sector within that because that’s where all the growth was last year. Healthcare became the number two sector. Fast forward to the end of June of this year, Russell does a rebalancing. And they have Russell 1000 Growth, Russell 1000 Value, 2000 Growth, 2000 Value, so they divide it by cap. But by that time, energy didn’t have those growth characteristics, so there was very little movement. As a result, here’s the wow. So Russell 1000 Growth Index this year is up, I think, 37% year-to-date. The S&P Pure Growth Index is up 2% year-to-date.

So the moral of that story is you better know what you’re buying. Not all growth indexes are created equal. It’s part of the reason why we take a factor approach, screen for invest based on characteristics. And in this environment, we’ve been emphasizing quality, probably with a more recent necessity of having a valuation kicker in there. It’s almost like what we used to think of as GARP, or growth at a reasonable price. And that’s how you actually screen for growth characteristics, value characteristics, without having to either, you know, name the stocks yourself based on preconceived notions or worry about index construction, because not all growth indexes are created equal and not all value indexes are created equal. So focus on the factors of growth and value, not the index labels. 

MARK:  Thank you, Liz Ann. Kathy, we’ve got multiple questions of various forms of will these enormous federal budget deficits end up driving up intermediate-term and longer-term interest rates, despite the Fed may be getting into rate cutting mode? 

KATHY:  Yeah, the question comes up a lot, and it’s a supply-demand question, treasury is going to be issuing more debt because our deficits are rising, and who is going to buy the debt, and does that mean that, you know, we’re going to have higher rates for longer? It’s certainly on the margin of factor, but over the long run in the US Treasury market, supply has almost zero statistical correlation with deficits and debt levels. So, right now, we’ve got a lot of concern because interest rates have gone up. That means financing the debt has gone up, as Mike mentioned. But we’re looking at, you know, still going from maybe 1.2% of GDP for financing costs, up to maybe 2.8, up to maybe 3.6 over the next 10 years. Relative to the size of the economy, it’s just not that large. 

Secondly, you know, the treasury is trying to manage the issuance to minimize the impact. Now, they’ve switched in the last quarterly refunding to issuing a lot more bills than expected instead of coupons. And I think the reason is because (a) they have to meet the market where the market is, and the demand at that point for bills was off the charts, everybody wanted to be in money market funds and money market funds wanted T-bills. And that was a way when the Treasury talks to Wall Street trading desks, they find out where the demand is, and they were trying to meet the demand. So they issued less in the way of coupons than anticipated, more in the way of bills. The advantage to that is if the Fed starts to cut rates in the next six months to a year, those are going to roll over at lower and lower yields. That effective cost is going to go down on the debt. 

But the big picture is that, you know, financing costs for the United States Treasury are not a major driver of yields over the long run. And I’ve done the statistical correlations, you know, numerous times, we’ve just updated it not long ago. There’s practically no correlation. And the reason is, you know, it’s the United States. We have a huge and dynamic economy. People want to invest in the United States. A lot of this stuff is on the margin. It can affect how we can spend money, it can affect certainly the political debate. And I’m not endorsing, you know, never ending rising deficits, but I’m saying that focusing on that as a driving factor for yields is to ignore the big factors which are, what is the Fed doing? What’s inflation doing? What’s the economy doing? Those are the ones that have the highest correlation with yield over time. 

MARK:  Alright, thank you. Thank you, Kathy. Jeff, this one is for you. With respect to economic data out of China, do you have a high degree of confidence in the accuracy and transparency of the data they provide? 

JEFF:  It’s a good question. I get it a lot. No, is the answer. I don’t have a high degree of confidence. And that’s, I think, not because I think they’re trying to lie to us. I think they don’t have the processes or practices or incentives to create the type of accurate economic statistics that we value and use in the West. There are a lot of other reasons for the data not merely to track the economy. 

So what you’ll hear from me often is about air pollution, which I can get from US State Department officials, you know, in the cities around China, which they do every hour on the hour. You can get that data; anybody can get that data. I know very few people who look at it. I do, always have. I look at earth-moving equipment exported from Japan, which I can get on a monthly basis to see, you know, how much infrastructure investment is taking place in China. I can look at box office results reported every weekend from the likes of Disney and others about, you know, what were their numbers in China. I can look at Starbucks, I can look at Sketchers, I can look at so many different companies around the world and their results, in terms of what they’re selling into China in terms of their end products and their materials. I can look at, you know, a lot of different indicators that I think do have a lot of accuracy and I do have a lot of confidence in, that give me some confidence that I know what I’m talking about when I’m talking about China’s economy. Let me say that the data coming out of the National Statistics Bureau in China has aligned more and more with those alternative measures that I’ve used for decades. I’d say over the last five years they’ve gotten better, but they’re not at the level of what we would consider to be normal practices for economic data that we use in the West. 

So I do rely on a lot of this third-party data, which I’ve gotten very comfortable with. And I feel like, you know, China’s economy did slow down very rapidly this year. Is now showing some signs of stabilization, but it’s still a bit of a wild card as to how much that stabilization takes root next year. Are they going to hit another 5% GDP target next year? I think it’s still an open question. 

MARK:  Thanks, Jeff. Liz Ann, we’ve got a couple of questions here about consumer debt. First one is, ‘What is your expectation for the economic impact of current consumer credit card debt levels?’ And then a different question here, ‘Do you have any commentary on consumer debt in the US? Has there been a steady buildup? Any concern over the popularity of buy now and pay later payment policies?’

LIZ ANN:  Yeah, so there was a recent report that we wrote that I’m pretty sure is still on schwab.com/learn. Unfortunately, I don’t remember the name of it off the top of my head, but I believe it is still posted if you scroll through. There’s a lot of ways to slice and dice this. In terms of just the increase in debt, yes, you’re seeing it across the board. Obviously, the cost of servicing that debt has gone up quite a bit. Delinquencies have really, really surged, but the significant surge has been concentrated mostly down in and around the sub-prime area, although overall delinquencies are starting to pick up particularly for credit cards and also for auto loans. Much less severe problems on the mortgage side of things. Even on the student loan side of things, not all that bad. 

I do think that given sky-high interest rates on credit cards, there has been a shift toward buy now/pay later. You’ve seen it in the commentary around the Black Friday, into Cyber Monday, the data that came out around retail sales and consumption showing just a pretty mild pickup in credit card usage, I think to the tune of 2% reported by MasterCard, I believe, and it was a 20% increase in the case of buy now/pay later. So I think there is money shifting because of the higher fees and/or higher rates. That doesn’t mean there isn’t a pending problem. Even if you’re not paying exorbitant interest rates, if you buy now and you can’t pay later, it becomes a problem. 

In general, the cost of servicing the debt relative to incomes is nowhere near as elevated as just the absolute levels. But of course, if we continue to see some movement down in wages and incomes in conjunction with the softening in the labor market, then those problems start to show themselves a little bit more clearly. 

MARK:  Alright, thank you, Liz Ann. Let’s see, Kathy, got a couple questions here about the Fed losing money. So Kathy, ‘Do the interest rate-induced paper losses on the Fed’s balance sheet matter?’ Another question here, ‘Do you have concerns about the Fed losing large amounts of money?’ 

KATHY:  The answer is no. It’s an accounting entry and there’s no… you know, it’s an ongoing entity, so solvency isn’t an issue. It’s a political concern. It attracts a lot of attention, and people like to make, you know, an issue out of it. But in general, it’s the lender of last resort, it’s able to go on with paper losses for a while. 

I think, though, that one reason the Fed is so motivated to get the balance sheet down is so that they can do away with some of those. You know, they’re used to remitting to the Treasury, not having to take money, essentially, on paper from the Treasury. They would like to get back into that situation, and part of that is to get some of the bonds off the balance sheet. But those bonds will mature off the balance sheet eventually, so… matter of fact, there’s no effect on the economy, there’s no effect on interest rates, there’s no net effect. It’s just… I suppose it’s a political embarrassment and it’s a talking point, but net effect on policy or on the markets is very low. 

MARK:  Thanks, Kathy. Mike, I’ve got a question for you. Interesting one. ‘Does Mike have a regulatory view of cannabis and changes to the 280(e)  Tax Code or rescheduling it?’

MIKE:  Well, the big thing on Capitol Hill around cannabis is whether the banking system is going to be sort of opened up to cannabis-related businesses. And that’s been something that the industry has been pushing for a long time, and there’s a lot of bipartisan support for that. It hasn’t happened yet, but I do think there’s a shot that may happen in 2024. That’s something that we’re going to watch. On the tax issue, that’s not one that I’ve got a real update on right now. It just hasn’t been on my radar screen recently. 

MARK:  Great, thanks. Thanks, Mike. Kathy, got a question, a couple questions here about preferreds. Let me see which one here? Yeah, ‘What are your thoughts on preferred stocks in 2024? Have they bottomed?’ 

KATHY:  Yeah, it looks like they probably have. You know, the two issues with preferreds that are the key risks are there are generally issued by bank and finance companies, and they’re very long duration, sometimes perpetual, so they’re very sensitive to interest rate movements. So we’ve seen interest rates come down, so that should help. There’s been, of course, a lot of weakness in the banking sector, and that has weighed on preferreds as well. 

It looks like… you know, I could probably defer to Liz Ann on the outlook for the banking sector, but recently that has shown improvement. We’re probably through the worst of it, and so that should help preferreds. And the interest rate outlook is improving . Especially when and if the Fed pivots to cutting rates, that should help. 

But, you know, I do want to emphasize that the preferreds that we’ve talked about looking attractive at the low dollar prices are the ones issued by the larger bank and finance companies with the more solid balance sheets and that buffer. Those are the ones that are least likely to have some sort of an issue with them or more volatility. 

So it looks like the interest rate part has improved. The bank and finance outlook seems to be improving. So we do think preferreds going forward should do better in 2024. 

MARK:  Thank you, Kathy. Liz Ann, this one is for you. ‘What does Liz Ann…’ did I get the right one? I lost my place here. Oh, here we go. ‘Doesn’t 30% growth in small-cap earnings in the face of a recession seem a bit optimistic?’

LIZ ANN:  Yeah, that’s why I said the swing factor is high. Whether you want to trust those out estimates, I think, it probably is a stretch. I think maybe estimates, out estimates for the S&P 600 probably have a little bit more accuracy again, because of that profitability filter. What’s hard to gauge inside an index like the Russell 2000 are the 31% that are zombie companies, close to 40% that are not profitable. So the whole notion of the denominator, I think, is so screwy because of the unique nature of that index. So I think analysts have moved away from long-term sort of precise forecasting. And I think I mentioned when I addressed this in the opening remarks, I think they’re sort of keeping their cards closer to the vest, meaning not really making any significant adjustments to out-estimates, other than during earning season for the subsequent quarter. And that’s why you’ve seen a lot of movement in fourth quarter estimates, all of which have come down, both for the S&P, for the S&P 600, for the S&P 500, and not much movement in the full calendar year 2024. 

So I would agree. I think those estimates… it’s what we have to go on. My point was that it could be driving money down the cap spectrum where there’s that perceived leverage to a bigger swing factor in earnings. But I wouldn’t put a lot of weight on the numbers for calendar year 2024. I don’t think they reflect reality.

MARK:  And quickly, Liz Ann… we’re almost out of time here. We’ve got a question here. ‘Could you please define a zombie company.’

LIZ ANN:  That don’t have the cash flow to pay interest on their debt on a rolling basis. 

MARK:  Alright, we are going to wrap it up there. Liz Ann Sonders, Jeffrey Kleintop, Kathy Jones, Mike Townsend, thanks for your time today. 

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The next call in this series will be February 6^th at 8:00 AM. 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, please reach out to a Schwab representative. Thanks for your time, and have a nice day.

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The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision. All expressions of opinion are subject to change without notice in reaction to shifting market, economic or political conditions.  Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.  Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

Past performance is no guarantee of future results and the opinions presented cannot be viewed as an indicator of future performance.

Investing involves risk, including loss of principal. Fixed income securities are subject to increased loss of principal during periods of rising interest rates.

Fixed income investments are subject to various other risks including changes in credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications, and other factors.

Performance may be affected by risks associated with non-diversification, including investments in specific countries or sectors. Additional risks may also include, but are not limited to, investments in foreign securities, especially emerging markets, real estate investment trusts (REITs), fixed income and small capitalization securities. Each individual investor should consider these risks carefully before investing in a particular security or strategy.

All corporate names and market data shown above are for illustrative purposes only and are not a recommendation, offer to sell, or a solicitation of an offer to buy any security. Supporting documentation for any claims or statistical.

Diversification and asset allocation strategies do not ensure a profit and cannot protect against losses in a declining market.

Schwab does not recommend the use of technical analysis as a sole means of investment research.

Rebalancing does not protect against losses or guarantee that an investor’s goal will be met. Rebalancing may cause investors to incur transaction costs and, when a non-retirement account is rebalanced, taxable events may be created that may affect your tax liability.

The information and content provided herein is general in nature and is for informational purposes only. It is not intended, and should not be construed, as a specific recommendation, individualized tax, legal, or investment advice. Tax laws are subject to change, either prospectively or retroactively. Where specific advice is necessary or appropriate, individuals should contact their own professional tax and investment advisors or other professionals (CPA, Financial Planner, Investment Manager) to help answer questions about specific situations or needs prior to taking any action based upon this information.

Source: Bloomberg Index Services Limited. BLOOMBERG® is a trademark and service mark of Bloomberg Finance L.P. and its affiliates (collectively “Bloomberg”). Bloomberg or Bloomberg’s licensors own all proprietary rights in the Bloomberg Indices. Neither Bloomberg nor Bloomberg’s licensors approves or endorses this material or guarantees the accuracy or completeness of any information herein, or makes any warranty, express or implied, as to the results to be obtained therefrom and, to the maximum extent allowed by law, neither shall have any liability or responsibility for injury or damages arising in connection therewith.

Index Definitions

Indexes are unmanaged, do not incur management fees, costs, and expenses, and cannot be invested in directly. For more  information on indexes please see schwab.com/indexdefinitions.

Forecasts contained herein are for illustrative purposes only, may be based upon proprietary research and are developed through analysis of historical public data.

Data contained herein from third party providers is obtained from what are considered reliable source. However, its accuracy, completeness or reliability cannot be guaranteed and Charles Schwab & Co., Inc. expressly disclaims any liability, including incidental or consequential damages, arising from errors or omissions in this publication.

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.

Investing involves risk, including loss of principal.

Performance may be affected by risks associated with non-diversification, including investments in specific countries or sectors. Additional risks may also include, but are not limited to, investments in foreign securities, especially emerging markets, real estate investment trusts (REITs), fixed income and small capitalization securities. Each individual investor should consider these risks carefully before investing in a particular security or strategy.

Diversification strategies do not ensure a profit and do not protect against losses in declining markets.

International investments involve additional risks, which include differences in financial accounting standards, currency fluctuations, geopolitical risk, foreign taxes and regulations, and the potential for illiquid markets.

Investing in emerging markets may accentuate these risks.

Indexes are unmanaged, do not incur management fees, costs and expenses, and cannot be invested in directly.

Commodity-related products, including futures, carry a high level of risk and are not suitable for all investors. Commodity-related products may be extremely volatile, illiquid and can be significantly affected by underlying commodity prices, world events, import controls, worldwide competition, government regulations, and economic conditions, regardless of the length of time shares are held. Investments in commodity-related products may subject the fund to significantly greater volatility than investments in traditional securities and involve substantial risks, including risk of loss of a significant portion of their principal value. Commodity-related products are also subject to unique tax implications such as additional tax forms and potentially higher tax rates on certain ETFs.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness, or reliability cannot be guaranteed.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

Supporting documentation for any claims or statistical information is available upon request.

Tax-exempt bonds are not necessarily a suitable investment for all persons. Information related to a security's tax-exempt status (federal and in-state) is obtained from third parties, and Charles Schwab & Co., Inc. does not guarantee its accuracy. Tax-exempt income may be subject to the Alternative Minimum Tax (AMT). Capital appreciation from bond funds and discounted bonds may be subject to state or local taxes. Capital gains are not exempt from federal income tax.

The policy analysis provided by the Charles Schwab & Co., Inc., does not constitute and should not be interpreted as an endorsement of any political party.

Indexes are unmanaged, do not incur management fees, costs, and expenses and cannot be invested in directly. For more information on indexes please see schwab.com/indexdefinitions.

A bond ladder, depending on the types and amount of securities within the ladder, may not ensure adequate diversification of your investment portfolio. This potential lack of diversification may result in heightened volatility of the value of your portfolio.  As compared to other fixed income products and strategies, engaging in a bond ladder strategy may potentially result in future reinvestment at lower interest rates and may necessitate higher minimum investments to maintain cost-effectiveness. Evaluate whether a bond ladder and the securities held within it are consistent with your investment objective, risk tolerance and financial circumstances.

Treasury Inflation Protected Securities (TIPS) are inflation-linked securities issued by the US Government whose principal value is adjusted periodically in accordance with the rise and fall in the inflation rate. Thus, the dividend amount payable is also impacted by variations in the inflation rate, as it is based upon the principal value of the bond. It may fluctuate up or down. Repayment at maturity is guaranteed by the US Government and may be adjusted for inflation to become the greater of the original face amount at issuance or that face amount plus an adjustment for inflation. Treasury Inflation-Protected Securities are guaranteed by the US Government, but inflation-protected bond funds do not provide such a guarantee.

Mortgage-backed securities (MBS) may be more sensitive to interest rate changes than other fixed income investments. They are subject to extension risk, where borrowers extend the duration of their mortgages as interest rates rise, and prepayment risk, where borrowers pay off their mortgages earlier as interest rates fall. These risks may reduce returns.

Bank loans typically have below investment-grade credit ratings and may be subject to more credit risk, including the risk of nonpayment of principal or interest. Most bank loans have floating coupon rates that are tied to short-term reference rates like the Secured Overnight Financing Rate (SOFR), so substantial increases in interest rates may make it more difficult for issuers to service their debt and cause an increase in loan defaults. A rise in short-term references rates typically result in higher income payments for investors, however. Bank loans are typically secured by collateral posted by the issuer, or guarantees of its affiliates, the value of which may decline and be insufficient to cover repayment of the loan. Many loans are relatively illiquid or are subject to restrictions on resales, have delayed settlement periods, and may be difficult to value. Bank loans are also subject to maturity extension risk and prepayment risk.

The comments, views, and opinions expressed in the presentation are those of the speaker. The content presented here is intended for informational purposes only. The information is not intended to provide tax, legal, or investment advice; please check with your investment advisor for how it applies to your specific situation. Certain information presented herein may be subject to change. Neither the presentation nor any information or material contained in it may be copied, assigned, transferred, disclosed, or utilized without the express written approval of Charles Schwab & Co., Inc. (“Schwab”).

Digital currencies [such as bitcoin] are highly volatile and not backed by any central bank or government. Digital currencies lack many of the regulations and consumer protections that legal-tender currencies and regulated securities have. Due to the high level of risk, investors should view digital currencies as a purely speculative instrument.

Environmental, social and governance (ESG) strategies implemented by mutual funds, exchange-traded funds (ETFs), and separately managed accounts are currently subject to inconsistent industry definitions and standards for the measurement and evaluation of ESG factors; therefore, such factors may differ significantly across strategies. As a result, it may be difficult to compare ESG investment products. Further, some issuers may present their investment products as employing an ESG strategy, but may overstate or inconsistently apply ESG factors. An investment product’s ESG strategy may significantly influence its performance. Because securities may be included or excluded based on ESG factors rather than other investment methodologies, the product’s performance may differ (either higher or lower) from the overall market or comparable products that do not have ESG strategies. Environmental (“E”) factors can include climate change, pollution, waste, and how an issuer protects and/or conserves natural resources. Social (“S”) factors can include how an issuer manages its relationships with individuals, such as its employees, shareholders, and customers as well as its community. Governance (“G”) factors can include how an issuer operates, such as its leadership composition, pay and incentive structures, internal controls, and the rights of equity and debt holders. Carefully review an investment product’s prospectus or disclosure brochure to learn more about how it incorporates ESG factors into its investment strategy.

Please note that this content was created as of the specific date indicated and reflects the author’s views as of that date. It will be kept solely for historical purposes, and the author’s opinions may change, without notice, in reaction to shifting economic, business, and other conditions.

All corporate names and market data shown above are for illustrative purposes only and are not a recommendation, offer to sell, or a solicitation of an offer to buy any security. Supporting documentation for any claims or statistical information is available upon request.

Preferred securities are a type of hybrid investment that share characteristics of both stock and bonds. They are often callable, meaning the issuing company may redeem the security at a certain price after a certain date. Such call features, and the timing of a call, may affect the security’s yield. Preferred securities generally have lower credit ratings and a lower claim to assets than the issuer's individual bonds. Like bonds, prices of preferred securities tend to move inversely with interest rates, so their prices may fall during periods of rising interest rates. Investment value will fluctuate, and preferred securities, when sold before maturity, may be worth more or less than original cost. Preferred securities are subject to various other risks including changes in interest rates and credit quality, default risks, market valuations, liquidity, prepayments, early redemption, deferral risk, corporate events, tax ramifications, and other factors.

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.