MARK RIEPE: Good morning, everybody. Welcome to Schwab Market Talk. Thanks for your time today. It’s August 5th, 2015. 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 the Schwab Center for Financial Research, and I’ll be your moderator today. We do these events monthly, and we’re going to start out by spending about 30 minutes or so talking about some of the top themes on the minds of our strategists, and then we’ll start taking live questions. So you can ask a question at any time. Just type the question into the Q&A box on your screen, and click Submit, and we’ll be… as I mentioned, we will focus on those in the last half of the show. For continuing education credits, live attendance at today’s webcast qualifies for one hour of CFP and/or CIMA continuing education credit if you’ve watched for a minimum of 50 minutes. That means if you’ve watched the replay, you aren’t eligible for CE credit. To get CFP credit, please enter your CFP Number in the window that should be popping up on your screen right now. In case you don’t see that, don’t worry about it, we’ll show it again towards the end of the webcast, and then Schwab will submit your credit request to the CFP Board on your behalf. For CIMA credit, you’re going to have to submit that on your own. Approximately 50 minutes after the show started, the directions for how to submit will be found in the CIMA widget that will be appearing at the bottom of your screen. Finally, I want to call your attention to a couple of resources on the webcast console. In the top right, you’ll see a link to our latest investment outlook for advisors, and in the bottom right-hand corner you’ll see a link to some additional resources, including a chart on how volatility can create opportunities in bonds for your clients.

Our speakers today are Kathy Jones, our Chief Fixed Income Strategist; Kevin Gordon, a director here and our Senior Investment Strategist; and Michelle Gibley, a director in our Global Equity Research Group.

And we are going to start out with you, Kathy. The Fed had their meeting last week. What do you think… you know, they released their statement. Of course, now we’ve got the Jobs Report. What’s your outlook going forward for the rest of the year in terms of rate cuts?

KATHY: Yeah, we are sticking with a call that there would be a rate cut in September and another one in December, which is kind of where we’ve been all year because we thought it would take until the fall, several months until the fall to feel the impact of the tariffs, immigration policy changes, and other policy uncertainty. And I think that’s where the market is now. The market is discounting 100 basis points and rate cuts over the next year. That seems pretty reasonable to us. I think there’s a balancing act that the Fed has to do because inflation is still stuck, and turning a little bit higher. Some of this is due to the tariff impact, and they’ll have to try to look through that in order to lower rates. But in response to the weakness in the jobs market, that really does give us a different picture of where we are today in terms of a slowing economy, and that’s the other half of the Fed’s mandate. So it looks to me like we get a rate cut in September, another in December. It wouldn’t surprise me to see another series of rate cuts in next year, assuming that this continues, the pattern continues to slower growth. The assumption will be that eventually lower demand will bring down inflation, but it does depend on how inflation performs. I think the Fed could get to points where they kind of pause for a while if inflation really isn’t starting to head towards their 2% target.

MARK: Kathy, there were a couple of dissents. How unusual is that? Because I think the belief is that usually it’s a very consensus-driven organization, two dissents seems on the higher end. What do you think?

KATHY: Yeah, that’s true. We haven’t seen many dissents in the last 10 or 20 years. The Fed has evolved to be a very consensus-driven organization, and usually what happens is prior to the meeting I know the Fed Chair will go around and discuss the views of the various members of the committee, and try to form some sort of consensus, not just around the vote but also around the language contained in the statement, so that they’re presenting kind of a unified voice. But dissents are going to happen from time to time, particularly at turning points, and I think we have hit a bit of a turning point here where the economy is softer than expected, the job market is softer than had previously been estimated, and I think at turning points you do see more in the way of dissents.

But overall two votes out of the total committee, you know, 18 votes is not that much. I think in some ways these dissents were signals that the various individuals might be sending that they want to stand out. There is going to be a new Fed Chair, we all know, next year, and I think to some extent this is signaling and saying, ‘Hey, I have a different point of view. Pay attention to me.’

MARK: Yields dropped after the weak Jobs Report came out on Friday. Do you expect that to continue for the rest of this year? And then what’s your outlook into 2026?

KATHY: Yeah, we do… because we look for the Fed to ease rates, we do think yields will fall into next year. We don’t, however, see long-term, intermediate- to long-term rates coming down as much as short-term rates. So that steep yield curve will probably continue and maybe steepen a bit more. So your short end is going to follow what the Fed does, and if 100 basis points is accurate or close to it, then you’re going to see those short-term yields fall. The two-year is almost there already. But when you get an intermediate- and long-term, you have sort of offsetting things, so that will depend on prospects for growth, and for inflation and inflation expectations, And inflation expectations are down, but they’re not down at a level… they’re not at 2%. Inflation is stuck at 2.8 or so and edging higher. Until we get through the tariff business and see how that affects prices fully, that’s going to have an effect of lifting the long end. We also have immigration restrictions that are keeping the unemployment rate low and possibly could nudge up wages a bit, and costs for businesses which may get passed along to consumers. And then you have the large federal debt, which could also play a role in keeping yields from falling too much at the intermediate and long end of the curve just because there’s so much financing to be done. So steeper yield curve, yes, yields falling across the spectrum, but maintaining a relative steepness in the yield curve.

So I’d be surprised… I wouldn’t be surprised to see 10-year yields in treasuries hit 3.80, 3.75 or so. I think getting much below that and staying below that would require a much weaker outlook for the economy and much better inflation than we’ve seen.

One thing though, I will say barring some sort of, you know, kind of major financial disaster or economic problem, the world of zero short-term rates and 2% long-term rates I think is behind us. I don’t think we’re going to revisit that again, barring some catastrophe. I don’t think we’ll see that again anytime soon.

MARK: For those who don’t know, Kathy co-hosts a great podcast called On Investing with Liz Ann Sonders. Kathy, a couple of weeks ago you had our colleague, Collin Martin, on, and you were talking about some interesting trends in corporate bond issuance. What were you seeing there?

KATHY: Yeah, issuance has stayed pretty strong this year despite what we’d call kind of a decline in fundamentals. So… or, you know the peak in core for profits seems to be behind us, and the trend in terms of credit quality is probably going south rather than north now, and not at a rapid pace, but enough to make a difference. But I think companies are seeing a wide open market for issuance, and they’re continuing to take advantage of that. Issuance is up on a year-over-year basis by a little bit, and suggests to me that we’re going to see continued issuance as long as corporate spreads are so low. Right now, in investment-grade and in high-yield, they’re very, very low. So I would think issuance will stay pretty healthy as long as the market stays open. And these yields are pretty attractive. If you’re an investment-grade issuer, you can issue all-in 5% or a little bit lower. That’s pretty attractive for a lot of folks in the corporate world to take on debt at that level.

MARK: Last question for you, Kathy, and then we will bring Michelle in. Is there a sweet spot on the yield curve? And I guess I’ll follow up to that is what’s your overall view on credit? In the past, you’ve talked a lot about tilting the portfolio towards the higher-quality spectrum of the credit curve.

KATHY: Yeah, so in terms of sweet spot in the market on the yield curve, it’s still probably in the intermediate part of the curve. We favored five to seven. I think maybe a little bit longer even now that it looks like the tide has turned, five to 10 years. You get most of the yield that’s offered in the market without taking on the investment risks, which you get at the short end, or too much interest rate risk that you get at the long end. Because we do look for return of volatility. We’ve had a pretty low volatility environment for a couple of months. I think as we get into the fall, we’ll probably see volatility pick up again. So we kind of like that intermediate part of the curve consistent with the Ag, the Bloomberg Aggregate Bond Index. I think that has a duration of about six to six and a half years, and that’s a pretty attractive place on the yield curve.

As for limiting exposure to low-quality credit, we’re still in that camp just because spreads are so low, and we’re seeing some deterioration. Again, corporate profits have probably peaked on the way down for the cycle, and with high-yield issuers, of course that’s a bigger concern than it is in investment-grade. And so having too much exposure to high-yield at this stage of the game is probably not advantageous just because you don’t get paid to take a lot of risk. The spreads are so low. We always say it’s okay to take risk when you get paid for it, and if you’re not getting paid for it, you probably want to limit exposure to the low end of the spectrum.

MARK: Great, thank you. Thank you, Kathy.

Michelle Gibley, why don’t we maybe start at the most obvious place for when we talk about international markets, tariffs. What’s the latest on tariffs?

MICHELLE GIBLEY: Yeah. Well, we have these so-called trade deals with countries that represent about one-third of US imports, but these really are not signed deals. They’re just frameworks for future deals, and frankly, the details in many parts are scant. Then we have these new reciprocal duties that were announced last Friday, Thursday night, set to go in place this Thursday, August 7th, and that creates opportunities for more deals to be made this week In particular, we’ll be watching Switzerland and Canada. Additionally, the executive order says that the new tariffs don’t apply if countries are currently in negotiations with the US, so we don’t really know what that means yet either. We have these new commitments to invest in the US. Those were added to the EU, Japan, and South Korea deals. This is interesting and creative, but there’s still a lot of unknowns here as well. We don’t know the competition of investments, how much is new commitments versus investments already planned, and there’s some disagreement on both sides on how the investment will work. But there’s also a lack of details on the timeframe for these investments, and the size of investment is really quite large compared to the size of these other countries’ economies. So it’s unclear if these investments will actually play out.

Importantly, we still have three major trading partners yet to have deals. That would be Canada, Mexico, and China. On July 31st, President Trump announced another 90-day reprieve for Mexico. China’s deadline of August 12th is likely to get extended another 90 days. And then meanwhile, Canada was hit with a 35% tariff on Friday for goods that are not covered under the USMCA, the US-Mexico-Canada Agreement.

Now, the effective tariff rate for the US has increased from 2.3% in January to 8.9% in May, but since then we’ve gotten these basically 15% across the board tariffs, and roughly 20% on Asian goods, and then tariffs on other countries, and we’re still waiting to hear about semis and pharmaceuticals. So the effective tariff rate is still rising.

Now, the worst case scenarios from early April appear off the table, but the economic hit is yet to be felt, and there’s a lag between tariff announcements to implementation, which then takes time to flow through to inflation.

MARK: Michelle, let’s look at this from the standpoint of these other countries. How important is the US trading relationship to them?

MICHELLE: The US is the largest economy in the world, but for many countries, goods exports to the US is a small percentage of their overall GDP. An example is in China. It might be surprising that goods exports to the US was only 2.3% of China’s GDP last year. Now, there are some exceptions, though, seven countries where goods exports to the US are more than 10% of their respective GDP. These would be Vietnam, Mexico and Canada, Ireland, Taiwan, Malaysia, and Thailand.

So let’s look at Vietnam. It’s got the largest goods export exposure to the US. It’s 30% of its GDP. Now, they got a trade deal with the US for 20% tariff, and that might actually feel like a relative win to them. So even with a 20% tariff, manufacturing in Vietnam may still be cost-effective versus the headache of moving manufacturing to the US, developing supply chains in the US. Now, Vietnam was also the first country to get a 40% transshipment tariff. And this is something that’s very important for a lot of Asian countries. Transshipment is a rerouting of goods made in China through Vietnam before heading to the US to avoid paying a higher tariff rate, the China tariff rate. Now, this 40% transshipment rate was also listed in these broad-based reciprocal announcements for all countries last Thursday. And China wasn’t singled out, but it’s ultimately the target here. Now, Vietnam and some other Asian countries might lose business, and experience a slowdown in growth if China’s goods are no longer routed to them. But it might be interesting, some businesses may find it better just to keep manufacturing in China, where the tariff rate is already increased by 30 percentage points from the start of the year to 42%, and that’s roughly in line with that 40% transshipment rate. And China has got very deep supply chains and logistics efficiency. It’s second to none there.

If we go back to China, its exports to the US fell 60% in June, but its overall exports still grew 5.9% in a month because it’s able to find other destinations to make up for the lost revenues. For example, China’s exports to ASEAN, that’s the Association of Southeast Asian Nations, that’s 10 countries, grew 17% in June. However, if goods initially destined for the US end up in smaller markets all at the same time, this could put downward pressure on prices due to the extra competition.

MARK: Michelle, it’s interesting that you mentioned China there because we’ve certainly heard in the US a desire to become less dependent economically on China. Do you see… again, if we look at it from the international standpoint, do you see a movement for those countries to become less reliant on the United States?

MICHELLE: Yeah, I think so. Outside of the US, other countries are pursuing more trade with each other. There’s actually quite a few trade deals either signed or underway this year. I’m going to quickly list the activity just so you can hear how many things are going on.

So this year UK and India made a historic free trade deal in May. And a four-nation group, including Switzerland, signed a trade agreement that was 16 years in the making with India in March. Canada and ASEAN are pursuing a free trade deal. Mexico and Brazil are working to deepen their trade agreements. China signed dozens of cooperation agreements with Vietnam and Malaysia in April, and signed a deal for zero tariff access for 53 countries in Africa in June, and is looking to strengthen its free trade agreement with ASEAN by October. The EU working toward a closer trade relationship with India and South Africa, and countries across Asia, including a potential free trade agreement with Indonesia by September.

Now, so we’ve got these shifting of exports originally destined for the US to other countries, and that might help to reduce the impact of the US tariffs, but due to the size of the US market, more trade between countries outside of the US is unlikely to completely replace the loss of trade to the US.

MARK: Alright, Michelle, last question for you, and then we’ll talk to Kevin. Emerging market stocks are doing well this year. I guess a two-part question. Why is that, and is it better from an investing standpoint to focus on maybe the whole category, the whole asset class, or try to pick individual countries?

MICHELLE: Yeah, you know, it might surprise people that emerging markets stocks have outperformed despite this trade dispute that disproportionately targets China, which is the largest weight in the EM Index, but it compares to similar circumstances in President Trump’s first term. During the first year of his first term, emerging markets outperformed all four quarters, and that’s despite new US tariffs then and trade policy uncertainty. And the potential reason for this outperformance is that sentiment toward emerging markets may have been low to start, but global growth held up better than expected, which is what we expect this time. And the US dollar fell in 2017, just like it’s following this year. Emerging markets are no longer tied to the use of commodities and the growth of commodities, but global tech trends are more dominant here. And tech- and internet-related companies are 37% of the EM Index as of June 30th, and major influences on three of the four largest country weights that would be China, Taiwan, and South Korea.

In terms of China and India, the largest and third largest weights, the domestic economy is a big influence on stock market returns. And China and India have traded places for the best EM stock returns in recent years and investing in individual countries can provide outside returns, but it also comes with higher risk. And so for this reason, I believe that having a diversified portfolio across EM countries is the best approach for most investors.

One last thing in terms of valuation, the MSCI EM Index is trading at 13 times next 12 months earnings. That’s above the 11.7 times 10-year average.

MARK: Thanks, Michelle. Kevin, let’s talk to you for a few minutes here. Last week was a big week. We had the different tariff announcements that Michelle has just discussed, we had the Jobs Report, we had a whole bunch of companies report earnings. Tell us where from your standpoint, the US economy is, given all of that news.

KEVIN GORDON: Yeah, so I think the Jobs Report at the end of the week was definitely what gave us the best read, especially because the labor market is so in focus when it comes to how tariffs are impacting it, and how, in particular, I think more importantly, over the long term, how immigration policy is impacting labor. And it’s been so much in focus from Friday, not necessarily for the July jobs print, which was weaker than expected. We had 73,000 jobs created. The consensus estimate per Bloomberg was above 100,000, but really the bulk of the focus has been the revisions for May and June. And when you take the combination of both of those months, you had almost 260,000 jobs that were revised out of the economy for both of those months, which is the largest that we’ve seen since the dark days of the pandemic. And when you actually look throughout history, it’s pretty rare to see that magnitude of a decline. You really only see it around recessions. So rightly so. I think a lot of the focus given you had such strong downward revisions, but also an increase in the unemployment rate to a new cycle high, that created a lot of fear that we’re slipping closer to recession, or the tariff war is starting to take more of a bite out of the economy.

I do think that as worrisome as the one report was with the revisions, the one thing to keep in mind, and this was also evident in the labor data for July, is that the run rate for the economy in terms of payroll growth has probably come down significantly. So you think about our ability to create fewer jobs without seeing the unemployment rate go up materially. That was essentially what happened in July, and what has happened so far this year. So you can see when we have this contraction in the labor force, in the labor supply, which is what we’ve seen this year, as that’s happening, it sort of brings supply down, but it also brings demand for labor down. So it’s a little bit of a race to the bottom for both of those things. With the benefit being we can create fewer jobs in the economy without seeing the unemployment rate go up, but the added rub that also brings the potential GDP growth for the country down as well.

So you do have both of those forces going on at the same time. And I think that was mostly evident in July for jobs, but also for the past three months. And I think the other important context to add to it in terms of supply really putting a constraint on how many jobs we can create and what the state of the labor market is, is the fact that you really haven’t seen a massive pickup in initial jobless claim. That’s sort of the best weekly sort real-time indicator that we have in terms of layoff activity and whether you’re starting to see mass layoffs take hold in the broader economy. So far, it’s not the case. You still have a pretty big gap between initial claims remaining low, and continuing claims remaining somewhat elevated, which just tells us that we’re still in this low hiring/low firing environment.

So I think that are definitely… you know, there’s definitely evidence that trade and tariffs have started to take a bite into labor because you look at some of the weakness in manufacturing payrolls, and trade and transport, and those industries that are at the epicenter of tariffs, but it’s not necessarily pushing the labor market or the economy into outright recession. So I think still, right now, the line and the distinction between those two is pretty firm.

MARK: So Kevin, given all of the twists and turns in policy since, let’s say, Liberation Day back in early April, at least the US stock market is close to all-time highs. So it seems to have shrugged off a lot of what we’ve been hearing recently. What’s behind that?

KEVIN: Yeah, so you look at the recovery, especially in an index like the S&P 500, it was actually the fastest recovery we’ve seen from that kind of, you know, if you want to call it a bear market shock because on an intraday basis it did move down more than 20%. So you kind of reached technical bear market territory if you were looking intraday. But regardless of whether you’re looking at closing or intraday, it was a pretty massive shock to the downside, equally massive if not more to the upside. And I will say, I think if you were just looking at the market’s move in sort of a narrative agnostic way, and just looking at the price participation, and the fact that a lot of sectors have done quite well since that low, it hasn’t just been a singular sector, or a tech, or a mega-cap story. You know, participation and breadth have definitely improved since then. I think a lot of it when you do start to break down and dissect the indexes moves, and what has driven us to all-time highs for… you know, 15 so far this year for the S&P, if you do look at the math of the index, it is a lot of those larger industries, whether it’s semiconductors, or parts of software, or parts of communication services, it is a lot of those that have helped drive the market higher. And that’s actually consistent with the fact that those industries, many of them actually have the highest profit margins in the economy. So if you have relatively high profit margins, and if the tariff story is mostly a margin story, then you probably have more absorption as an industry or as a company that resides in that industry.

So mathematically and logically it makes a lot more sense when you look at what has been out in front and what has been leading. But I also think when you start to expand it out to other areas of the services economy that haven’t been under as much pressure when it comes to tariffs, you think financial services as one of them, if they’re not as close to the epicenter of the tariff war, then they probably don’t see as much of a hit to earnings and as much of a hit to potential earnings. So it does kind of boil down to what does corporate earnings growth look like, not just in the past, but what does forward guidance look like. And as we’re learning in this earnings season, forward guidance is still relatively strong. Companies have been beating pretty nicely. The beat rate has gone up, the blended earnings growth rate has gone up as we’ve gone through this reporting season, there’s been a pretty healthy beat in terms of a company’s stock price relative to the market when they do beat on earnings, there’s been a significant loss the other way around when you miss on earnings, but that really just tells us that the bar has been set relatively low. So all of that is still working into this broader story in aggregate terms. Not that there aren’t industries that aren’t suffering, but in aggregate terms that right now you’re not seeing this massive fight that trade policy has taken out of the economy.

But we still think it’s sort of a process where you digest over time. Michelle talked about the tariff rate still moving higher. I mean there’s still a big gap between what is the announced tariff rate and what is the effective tariff rate. So as we continue to move more into double-digits for the effective tariff rate, we do expect you to see some more steam taken out of the economy.

MARK: Kevin, the last question for you, and then we’ll start answering some of the live questions that were submitted. Kathy had mentioned the Fed obviously concerned about the overall economy. The labor market is also concerned about inflation. What do you think the equity market is most attuned to right now, inflation or the employment situation?

KEVIN: It’s maybe not to be a cop out answer with both being the answer, but I do think that at least if you were maybe to prioritize the two, I think that inflation probably comes first just because you are starting to see, if you start to break down, whether it’s the CPI or the PCE, you are starting to see more inflation related to tariffs actually kick in and affect the broader economy. So if you just looked at even at just core goods versus core services, clearly core services as most people know, it’s a larger part of our economy. So whatever that is doing, it’s probably going to be a bigger driver of what the indexes that measure inflation are going to do.

But if you look at core goods, you’re actually starting to see a pretty significant move higher in inflation in that category. And actually within the PCE Index, the six-month change we’ve seen in core goods prices so far is something we haven’t seen dating back to the early 90s and the late 80s. So there has been a pretty significant pick… and I should say back to early 90s, late 80s, excluding the pandemic, of course. But you started to see some heat gather there, but it’s not yet spilling over into services. So I think that if that dynamic stays where you’ve got downward pressure and disinflation coming from services, but you still have some heat in goods, that probably is an okay signal, at least as it pertains to the Fed, where inflation is not getting out of control like it was from ‘22 into 2023, where goods inflation was leading to a pretty significant jump in services. So as long as you see that gap, I think it’s okay from an inflation side of things,

I do think that at the end of the day, if this translates into a weaker labor market, similar to the market reaction we saw on Friday, if that is the case where labor is slipping away faster and the labor demand is dropping more significantly, that’s leading to layoffs and the unemployment rate to go higher, then I think that would be definitely where the market’s focus shifts to, and that would be an all else equal negative outcome.

MARK: Great. Thanks, Kevin. Let’s see. We’ve got a lot of live questions, a lot of good questions here.

Kathy, I’m going to ask the first one of you. ‘If tariff revenue were to bring the deficit down to 1.4 trillion from 1.7 trillion, would that impact 10-year yields?’

KATHY: It seems very doubtful. The amount of revenue that can be raised from tariffs is not even equal to one year of interest payments on the federal debt. So it is a tax, and taxes do raise revenue, but it’s not going to be enough because the offsetting factor is lower demand, right? When prices go up, demand goes down, a lot of shifting around in the economy. So that probably means that even with the tariff revenue coming in, lower demand, that’s going to reduce tax collection. So all in all, it’s simply not enough to have a big impact on 10-year yields.

MARK: Thank you, Kathy.

Let’s see, Michelle, this one is for you. ‘How are you thinking about overall asset allocation? Would you be neutral on the US?’ I guess that’s developed markets and emerging markets relative to the equity index.

MICHELLE: Yeah, I think right now we like developed markets more than emerging markets just from a standpoint of valuation and earnings growth. If we look within Europe, that’s really the sweet spot right now. We’ve got stocks and cyclical sectors like financials and industrials outperforming, and that usually takes place when investors believe that growth is going to improve. They’re the two largest sectors in the MSCI EMU Index. That’s the Eurozone. They’re 24% and 21%, respectively. This earnings season misses are being punished like in the US, particularly in staples, discretionary, and tech, but financials are also doing really well. Sixty-one percent of financials are beating estimates, and they’re seeing the largest number of upside earnings revisions. They’re benefiting from a steepening yield curve. The Europe Stocks Index Bank Index is up nearly 50% this year. But despite that, it’s still trading at a discount to the S&P Bank Index. It’s trading at a price-to-book of 1.2 times versus 1.5 for the S&P.

MARK: Thank you, Michelle.

And let’s see, let me go… let me ask this one of Kevin. ‘Kevin, the recessions have typically followed a rate hike campaign, but not more recently. Why do you think that is?’

KEVIN: Yeah, so if you date it back to 2022 and 2023, I mean we were still working off a pretty significant reopening effort for the broader global economy, but also for the US economy. What that was doing was really engineering a ton of demand in the services component of the economy because that’s what we were most focused on reopening. So with that came pretty significant labor demand, came pretty significant consumer spending in that in that sector. It sort of created this, I guess, virtuous cycle at the time, at least for… not for inflation, but definitely for consumer spending and the overall healthy environment for services. So that provided a pretty significant, more than significant, I would say, cushion for the economy even if you had the Fed hike rates as aggressively as they did. Yes, that impacted the interest-sensitive parts of the economy. We had been calling it for quite a while, you know, rolling recessions that hit housing and manufacturing, but that was just happening sort of in the background or in isolation. There was sort of a narrow set of factors that were being… or indicators that were getting hit like they would normally in a recession. And that’s also inclusive of some of the survey data that we track. Whether it’s consumers or whether it was businesses, all of that was telling you that you were going into recession, but if you weren’t looking at the sort of bulk in the cushion that was on the services side, you were sort of missing that story of how much that was propping up the economy.

So we’re still kind of working within that. Even within everything going on in terms of trade policy today, we’ve learned in this earning season that there are certain industries that are getting hit much harder. I would put autos definitely in that category. But they’re just not a big enough part of the economy. So if you’re not going to hit what has become a larger driver either on the services side or on the tech, you know, AI side, then you’re not probably going to see that much of a hit to the broader economy. You would need to see much more pain, I think, for some of those interest-sensitive sectors. And if you didn’t see it happen in ‘22 or ‘23, it would be a little bit harder to see it now. Not to say that it’s not the case that it can’t happen, but I think that needs to be an important distinction, especially because we’ve become increasingly services dominant in the post pandemic era.

MARK: Thank you, Kevin.

Alright, Kathy, why don’t we turn this into the municipal bond hour? We’ve got I think at least three sets of questions here about munis, so I’m going to take these one at a time. ‘With the underperformance of munis in the first half of this year, do you think those yields on high-quality munis are now attractive, or will we see another wave of oversized issuance in the second half of the year? Anything on the direction of munis is appreciated.’

KATHY: Yeah, we do think the yields on munis are attractive there. And the question is positioning it correctly. There’s been a lot of heavy issuance. Issuance tends to be seasonal in the muni market anyway, been a lot of heavy issuance as state and local governments try to get ahead of some of these spending cuts that are coming, and raise funds for various projects. But we do think the valuations are attractive relative to spreads that you see in other markets. You know, after-tax yields are attractive. We think issuance will tend to start to come down in the second half of the year, not only seasonally, but because a lot of states, in particular, have tried to get ahead of this cycle in the business. So yeah, we like munis. And yeah, issuance has been big. It will probably continue to be pretty healthy, but I don’t think it is going to continue to increase. It’s probably going to dwindle down in the second half of the year.

MARK: Next muni question. ‘Is the amount of muni housing-related debt issuance over the past few years at a normal level or is it running at a higher level than normal? Should we be concerned or is this normal?’

KATHY: Well, I think it picked up, and it was the fall of 2023, I think, October of 2023, there was a passage of the Affordable Housing Finance Act, I think it was called. And that provided some enhancements to the issuance for housing-related activity, because the idea was to get the housing related activity picking up because the housing market has been so dead. And so I think that accounts for most of the pickup in issuance that we’ve seen over the last couple of years. As long as that act is in place, and there’s demand for affordable housing, which I think there is, then we’ll probably continue to see issuance stay reasonably high. Now, if we go into a downturn in the economy, that may be a place where state and local governments decide to pull back, or they don’t have the funding for affordable housing. But I think that overall housing-related debt in the muni market will probably stay… you know, issuance will probably stay up. It’s a new normal. We call it a new normal.

MARK: Alright. Thanks, Kathy. Last one on munis. ‘Given the…’ okay, here we go. ‘What is the impact of state and local budgets from federal cuts to education, healthcare, etc., and the impact to municipal bonds?’

KATHY: Yeah, so state and local governments have started to feel the impact of some of these cutbacks. I think that depending on how large they are and how long they persist, obviously it’s going to be a bit of a struggle for state and local governments that have relied on funding for education, medical care, etc. So it does put some stress on those budgets. And it may mean, though… I don’t think that we’re on the cusp of some sort of downgrade cycle or stress that… you know, governments, state and local governments have to balance their budgets every year, and so it means most likely if they do less. It’s rising unemployment and falling housing prices that are the most detrimental to municipal governments. So property taxes still continue to come in, unemployment rate is still pretty low. Most states aren’t feeling too much of pressure on that side. So their funding sources are still pretty good, but to the extent that they may rely on some of that education funds, and certainly the Medicare Medicaid cutbacks are going to be something of a burden. Most likely though, what’s going to happen, a lot of states are just going to… access is going to be denied, rather than states finding money to patch this up. So we’ll probably see a little bit of that in some of the bigger states that have more leeway, and can issue some debt to try to fill the gaps. But in other states, they’ll probably just allow people to fall off the roles.

MARK: Thanks, Kathy.

And Michelle, this one is for you. ‘Now that we’ve gotten a little more certainty on the tariff situation, what’s your outlook on global growth?’

MICHELLE: Yeah, we have a little more certainty, but it’s not completely certain yet. We still don’t have deals with China, Mexico, and Canada. And the deals with the EU and Japan are not legally binding, so they are subject to change in the future. But it does appear that most countries are not retaliating, and we have some clarity on the ceiling and floor for tariffs. For businesses, the tariff front loading from earlier this year has passed, and so we’re seeing a bit of a downturn in output, new orders, exports, and employment in July according to the Global Purchasing Manager Index for Manufacturing. So that indicates some near-term slowing in growth, but it’s actually slowing, but maybe at a more modest pace than initially expected.

The IMF put out its World Economic Outlook for July, revised up its outlooks for this year and next relative to April’s estimates. So they’re expecting growth this year of 3% for the overall growth, and then 3.1% next year. For reference, last year global growth was 3.3%. So it’s really just a modest slowing this year for the overall global economy, and then a re-acceleration next year from a lower base.

But under the surfaces there are some divergences. The IMF is expecting the US to slow by one percentage point to 1.9% this year, while Germany is expected to gradually pick up in growth over the course of this year and next. And this really falls in line with the idea of a new growth story in Europe driven by Germany who is looking to spend a trillion dollars over the next 10 years on defense and infrastructure. And that’s due to some big changes in their fiscal budget process. And this could really add 1-1/2% to growth every year for the next 10 years. And we’re seeing that reflected in German business sentiment, which is expectations about the future at a two-year high, and then Europe on unemployment is at an all-time low.

MARK: Thanks, Michelle.

Kevin, this one is for you. ‘If job growth is slowing, and the expectation is that that will eventually impact GDP, where do you see GDP growth in 2027 and 2028?’

KEVIN: Yeah, so we don’t give formal, I guess, targets around where GDP growth is going to be. I will say that if we’re going into this new normal of really constraining our labor supply growth, especially on the foreign born side… I mean I think if you put statistics around this and data around it, it sort of helps put it in context and frame it. So since the pandemic, excluding the past couple of months because of the contraction in foreign-born labor supply, that source of labor was by far the largest driver of our labor supply since right before the pandemic. We just haven’t had a lot of a bounce back and a lot of natural growth in the domestic born labor force, so we’ve looked to foreign born. And now that that’s reversed pretty significantly, you’ve brought, again, to my earlier point, the run rate of the economy just lower. So I think that all else equal, if you don’t see some epic surge in productivity, which even with AI-related things I’m not sure that’s going to show up right away, so I think that if you hold that relatively constant at a relatively okay growth rate, and you have the labor force contracting faster, that brings the potential growth rate for the economy down.

So I think, not to say that we should extrapolate the first half of this year, but when you look at the first half of this year, you averaged growth that was pretty slow, definitely a significant step down from closer to 3% that we were at last year, probably something closer to 1-1/2% for this year. Even if you look within consumer spending and business investment, those are sort sub 1%, sub 2%, respectively.

So you’ve definitely seen a downshift, but I think that there’s also an important distinction between going through that soft patch for growth and then going through a recession. You can have what is often thought of as a growth recession, where you do see growth slow enough, but you’re still growing as an economy. You’re not necessarily seeing an outright contraction. But I do think that probably the largest driver of that, assuming we see policy stay where it is in terms of this pickup in deportations, but also a pretty significant effective closure in terms of immigration flow into the country, as long as both of those stay in place, then you probably see a lower run rate for GDP growth going forward.

MARK: Thanks, Kevin.

Kathy, a couple of questions on TIPS. ‘Any thoughts on TIPS?’ A nice broad one there. A little bit more specific, ‘Are TIPS attractive here, and if so, at what tenor?’

KATHY: We do still like TIPS, and I think the reasoning is pretty clear, that if you have clients that are concerned about inflation TIPS, Treasury Inflation Protection Securities, is one way that you could actually keep pace with inflation. And that’s CPI inflation, that’s the overall inflation rate, so it’s not excluding this or that. So for a lot of clients that provides, I think, a lot of reassurance that they can at least keep pace with inflation.

The current breakevens are a little bit sub 2% now, so they’re not as attractive as they might have been a little bit ago when we were looking at 2.3, 2.4, but I think anything about 2% is probably still pretty attractive. Anything in this range is still pretty attractive simply because inflation is pushing a bit higher here, and I would look at it in the five- to 10-year area. Short-term TIPS you have to be really careful with. They’re kind of funky in the way that they adjust, particularly the real short-term ones. So we have a preference for individual TIPS rather than funds because you get a lot more control over the tenor that you put in. But between five and 10 here, there’s still some room here to lock in a 1-1/2- to 2% rate above inflation, which I think over that period of time is an attractive proposition.

MARK: Thank you. Thank you, Kathy.

Let’s see. Michelle, this one is you. ‘China has had a deflation problem. Why is that, and is the government doing anything to address this? And what are the implications for companies globally?’

MICHELLE: Yes, China’s problem is really too much supply and not enough domestic demand. And its government tends to spend on infrastructure when faced with a slowdown, which just further exacerbates the excess supply. The good news is that a meeting chaired by President Xi on July 1st called for regulating disorderly price cutting and excessive competition. So among the industries with excessive competition are electric vehicles, solar panels, lithium batteries, food delivery, steel and cement. And so there’s some optimism that excess capacity could be removed from the market, and that could help restore pricing and margins for businesses in these sectors. But really there’s a lack of details. If we get capacity cuts like in the 10% range, and the government provides support for the labor market, the economic impact may be small, but if we get broad cuts rapidly to a range of industries, that could significantly hurt growth and jobs.

And in terms of globally, what happens in China’s EV industry really has global implications. It accounted for 70% of global production last year according to the IEA.

MARK: Thank you, Michelle.

Kevin, this one is for you. ‘M2 money supply exploded in the pandemic. That’s not happening now. Should we still expect broad-based inflation again?’

KEVIN: So I’m not too big a fan of looking at M2 being a driver of inflation because not only in the post pandemic world has that correlation really weakened, but also in key moments of these bursts of inflation that we’ve had in history it’s not necessarily consistent with that burst in inflation, or a huge jump in prices following a burst in M2 growth. I think the last really significant lift in inflation that we had pre-pandemic was, of course, in the financial crisis era and the lead up to it, and it was actually the burst in money supply that followed the burst in inflation. So it was basically the opposite impact, or the opposite sort of follow on effect of what we experienced during the pandemic.

So I don’t think that we should necessarily think of it as that, especially because in the financial crisis era and from early 2000s up until the pandemic, it was more of a demand-led… you know, demand-driven economy, where we had seen interest rate policy really impact demand first, and then that led to an impact on the economy. This post pandemic era has mostly been all about the supply side. And I think that it was definitely evident in the pandemic when we were trying to reopen. We had a series of constraints both on the goods and the services side of the economy that created the conditions for inflation to really get out of the bag. Of course, exacerbated, I think we could all say by double-barreled monetary and fiscal stimulus, but again, kind of like we’re seeing now. You know, specifically within the goods sector in the economy, prices have been rising consistently this year almost every single month. So there has been more pressure there. You could argue that’s a supply side constraint because tariffs tend to be a supply shock.

So I’m not as big a fan, especially given the circumstances we deal with in today’s economy, in today’s backdrop, not as big a fan looking at M2 being the sole driver of it.

MARK: Alright. Thanks, Kevin.

Kathy, this one is for you. ‘With the expectation of 3.8% for 10-year rates, where do you see mortgage rates?’

KATHY: So mortgage rate is hovering around 7% or so now for 30-year fixed. If we come down to 3.8… you know, ,traditionally, the spread has been between 1-1/2- and 2.2 over 10-year treasury for mortgage rates, depending on supply and demand in the market. So I could use that as a sort of a benchmark and say 5-ish on the low end, 5-, 5-1/2 as sort of an average over the next couple of years. But if we do get that drop of 50 or 75 basis points, it probably will translate pretty directly into the mortgage market at this stage of the game. Obviously, a lot depends on supply and demand, how much demand there is for mortgage financing. I would assume that if we get a 5-handle, you know, anywhere in the 5s on 30-year fixed, we’ll see a surge in demand, and that will probably mean that there’s not a lot of room for yields to come down. But there should be improvement from where we currently sit because the spread is historically a little bit wide right now.

MARK: Thanks, Kathy.

Let’s see, this one is directed to both you and Kevin. We’ll give Kevin the first shot here. ‘How concerned are you about the quality of economic data in light of the firing of the head of the Bureau of Labor Statistics?’

KEVIN: So I think that there needs to be a pretty important distinction between the quality and the timing of when we get certain data. And I think the revisions process is certainly for the reason you just mentioned, that’s come into focus a lot. And this is not something new. I mean, revisions are a fact of life. I mean, we’ve always had them. It’s something that predates the pandemic. It’s very much a part of economics and when you gather data. We have seen much larger revisions post pandemic because response rates for a lot of the surveys that we get, whether it’s job openings, whether it’s the Non-Farm Payrolls Report, the Establishment Survey, which is what… you know, those two are the same, those have come down significantly. So where we were in the sort of mid to upper 60% range pre pandemic, we’ve dropped into the mid-40s, meaning when that first survey goes out to employers and businesses, because that’s what the Non-Farm Payrolls Report is, your response… you’re only getting around 45% of businesses that are responding on time. So as the next couple of months kick in, and you start to see more gathering of that data, that response rate does move up close to 100%, and that’s why you sometimes see these relatively large revisions. And I think in particular for the past couple of months, when you look at May and June, clearly those were the two months sort of in the aftermath of everything tariff-related. So if businesses had seen much weaker payroll growth, particularly in those industries that are more impacted by trade policies, so you think retail and construction and manufacturing and trade and transport, a lot of those industries actually saw the most significant revisions lower for those two months.

So I think that needs to be taken in context, that revisions are not a new thing. It is not suggestive of anything nefarious going on. The BLS has been under a lot of constraints in terms of resourcing and staffing, not just this year, but over the past several years. So that all needs to be thought of as really important context in terms of that agency, which is staffed with thousands of people, you know, not doing anything nefarious in terms of the data.

MARK: Kathy, what are your thoughts?

KATHY: Yeah, I mean, Kevin hit it on the head, you know, revisions happen. They’ve happened forever. I can remember revisions of over a million when benchmark revisions are done. And so these things happen for the reasons that Kevin cited. And there’s an old adage, big numbers get bigger and small numbers get smaller, and the reason is you get more data. So if we’re in an increasing trend, the more data you get, the more it increases. And similar story, and what I would say is certainly in terms of the employment numbers, the downward revision suggests that the numbers are going to get smaller.

But I think the more important issue for me is if we undermine the credibility of the government stats, then it makes it harder for people to make economic decisions. So that’s not a good thing. And secondly, of course, those are the benchmarks. So then we lean towards a private sector, and there are a lot of private sector numbers out there, a lot of various companies gather that sort of data, whether it’s price data or whether it’s employment data or what have you. And we do always compare those and look to those, the ones that have been around a while and have some reliability.

My theory is if we undermine the quality of the government statistics, then you have a flourishing of private sector information coming out that can likely be more biased and also distributed more unevenly. So one good thing about the government numbers is everybody gets them at the same time. If you are going to lean more towards, you know, rely more on private sector surveys, then those are going to be allocated based on who is going to pay the most. And that worries me in terms of the market functioning.

MARK: Thank you. Thank you, Kathy. Kathy, actually we’ll ask one last question then we’ll start the wrap up here. ‘What’s the appropriate split between short- and intermediate-term bonds within client portfolios?’

KATHY: Oh, that split just really depends on the client, and what the client’s needs and goals are, and when they need the money. One thing we’ve always favored for a lot of our retail clients is bond ladders, which kind of divides it up evenly. But I wouldn’t be too concentrated at the short end right now because I think reinvestment risk is a greater risk than rising interest rates. So an average duration around six to seven years or so, that could include some longer-term bonds out to 10 years and some shorter-term paper, depending on the client’s needs. That’s where I would be.

MARK: Thanks, Kathy.

Okay, last question for each of you. And what is the kind of one thought, one takeaway you want people to walk away from the webcast with? Michelle, why don’t we start with you?

MICHELLE: Yeah. Well, tariff rates are still on the rise, but other countries aren’t standing still. They’re increasingly doing trade with each other, and countries like Germany are taking steps they previously avoided to stand up and support their own economy. European stocks underperformed in July, as US tech stocks propelled the S&P 500 and a dollar a rose. But European stocks are still attractive longer term, with the MSCI EMU Index trading at 14 times next 12 months earnings below the 22 times for the S&P 500. And a resumption of dollar weakness could also add to returns.

MARK: Kevin, what are your thoughts?

KEVIN: Yeah, so I think in terms of looking at the markets rebound, it continued move higher. What I mentioned earlier in terms of margin strength and what sectors and what industries benefit the most, so to speak, in terms of relatively higher tariffs, if we’re going to live in this new world of higher tariffs, you do have to look at where margin strength is residing in the market. And for the most part, those have been the industries that make up a larger share of the market. So if those are going to get hit harder, then you probably have a little bit of a change in market behavior relative to what we’ve seen over the past several months.

I will say, though, with the rebound we’ve seen there has been… especially in the past month, there has been more of a catch up of sentiment getting a little bit more frothy and a little bit more optimistic and stretched. So sentiment, I would say, in an aggregate sense, combining what we look at in the attitudinal sphere, but also the behavioral sphere, that has definitely moved more into the riskier column. The catch is always that you can hang out there for a while until something comes along to tip you over. But I do think that evidenced by Friday, if you do get more negative labor data, that probably is the negative catalyst that maybe tips the market in the other direction, and has the potential to change the trend. But for now, the trend is still fairly strong, participation is fairly strong, but I would look for some of those dislocations if we do get a weaker set of labor data in the near future.

KATHY: My takeaway is, look, bonds look attractive. The tide is turned, I think. We’re on probably the cusp of some Fed rate cuts, slower economic growth, eventually lower inflation, and we think that that makes bonds attractive here.

MARK: We are out of time. So thanks to Kathy, Michelle, and Kevin. If you would like to revisit this webcast, we’ll be sending a follow up email with a replay link. To get credit, you’ll have to… continuing education credit, you’ll need to watch for 50 minutes in order to get that credit. To get CFP credit, please enter your CFP ID Number, and then click submit. You should be seeing that on the screen right now. And we will… Schwab will submit that the CFP credit request on your behalf. For CIMA credit, you’ll have to submit that on your own. Directions for submitting it can be found in the CIMA widget at the bottom of your screen. Our next webcast is September 9th, and Liz Ann Sonders will be with us, along with Kathy, Michelle, and Kevin. Until then, if you would like to learn more about Schwab’s insight, just contact your Schwab representative. Thanks again for your time, and have a nice day.

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