MARK RIEPE: Welcome to Schwab Market Talk, and thanks for your time today. It’s July 1^st, 2025. The information provided here is for general informational purposes only, and all expressions of opinion are subject to change without notice in reaction to shifting market conditions. I’m Mark Riepe. I head up to Schwab Center for Financial Research, and I’ll be your moderator today. We do these events monthly. We’re going to start out by discussing some of the top themes that are on the mind of our strategists. We’ll be doing that for about 30 minutes, and then we’ll start taking live questions. If you want to ask a question, you can just type the question into the Q&A box on your screen and click submit, and you can do that at any time during today’s event. 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. If you watch the replay, you aren’t eligible for any credit. To get CFP credit, you can just enter your CFP ID Number in the window that should be popping up on your screen right now. In case you don’t see it, don’t worry about that. We’ll show it again at the end of the webcast as well. And then Schwab will be submitting 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 has started, the directions for how to submit that can 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-hand corner, you’ll find a link to our Asset Allocation Hub for advisors, and in the bottom right-hand corner you’ll find a link to some additional resources, including a video on Active Fixed Income Strategy.

Our speakers today are Liz Ann Sonders, our Chief Investment Strategist; Collin Martin, one of our fixed income strategists; and Michelle Gibley, our Director of Global Equity Research.

And we are going to be starting out with you, Liz Ann, and we’re going to start off talking a little bit about the economy, and then we’ll switch to the stock market. Give us an update on the health of the economy as you see it ahead of the Jobs Report that’s going to be coming out on Thursday.

LIZ ANN SONDERS: Sure. And in no particular order, we’ve had generally weaker economic data. The most recent is ISM Manufacturing that came out today. Although the headline number did tick up a little, it remains in contraction territory, and the innards of the report had a little bit of that stagflation sort of, you know, look to them. You had weaker retail sales, weaker industrial production pretty much across the spectrum of the regional Fed data that has come out covering all of the various regions. Those also have generally showed weaker growth metrics, and a bit of upward pressure in the internal inflation metrics, things like prices paid, prices received. So I’d say, all in all, general weakness.

We did get some labor market data out today with the JOLTs. I’m not a huge fan of that survey. It’s the job Opening and Labor Turnover Survey. It lags all of the labor market data by a month. And the response rate has been cut in half over the last 10 years, not to mention the fact that when you think about the nature of job openings, in this world of everything happening digitally, and now with AI, I’m not sure it’s a true reflection of job openings. You can post something for free and forget to take it down. I’m not sure that’s a legitimate job openings. But that said, it is a metric that the Fed watches, and that the Fed watches it in conjunction with the total number of people unemployed and the relationship between those two. So it doesn’t matter what my personal opinion is of the metric. If the Fed watches it, we all have to watch it.

So in general, there’s a bit of that sort of stagflation whiff pretty much across the spectrum of most of the hard economic data that has come out. Not really a lot of exceptions showing strong growth in any particular category within the economy.

Oh, and then of course the big one, GDP, was revised down. The consumption portion of GDP was revised down by a pretty meaningful amount. Now, that’s only data through the first quarter, of course, which predates the April 2^nd reciprocal tariffs day. But it is suggestive of an economy that was weaker than originally thought heading into what became the era of tariff turmoil.

MARK: So Liz Ann, in the past, you’ve talked about sometimes there’s a kind of a divergence, if you will, between hard economic data and soft economic data. Are you still seeing that, and do you expect some sort of convergence to take place?

LIZ ANN: We actually had started to see a little bit of convergence. You saw a little bit of a bounce in some of the softer survey-based data, a little bounce in consumer confidence, and some other confidence measures at the same time you were seeing hard data resilience. The problem is that that convergence has sort of ended. Don’t know how long that will persist, but it has ended. So we track these surprise indexes. Citi has them, Bloomberg has them, and there is a pair of them out of Citi that separates the economic data into the hard and soft component. So these surprise indexes are tracking how data is coming in relative to expectations. It’s not tracking data relative to its prior history relative to the trend, just relative to consensus. And we actually just recently with the latest week’s worth of data, saw a re-rolling over of the soft data surprises at the same time the hard data surprises went from resilience in net positive territory now down into net negative territory. So both the hard data surprises and soft data surprises are now in net negative territory, which simply means that more data is coming in worse than consensus expectations than was the case even a week ago. I still think that there could be some convergence, in part because some of the soft data got so compressed that you get a little bit of reversion to mean, but do still expect some additional catch-down on the part of the hard data. And the most important hard data release coming up of course is Thursday, with the day-ahead release of the Jobs Report, given that Friday is a market holiday.

MARK: So given that backdrop, if we turn to the stock market, we see the S&P 500 near its all-time highs. What’s been driving that recovery from those April lows, and to what extent do you think that that rally has legs?

LIZ ANN: So I’d say in a broad sense, it makes me think of my oft-expressed mantra about how markets behave at times, which is that better or worse often matters more than good or bad. And that means as it relates to the connectivity between economic data releases and what the stock market does, or earnings releases and what the stock market does, I think it’s human nature for us to think about economic data or earnings data in strong versus weak or good versus bad. That’s human nature. But those are absolute analyses. I think it’s that better or worse. So if you think about what was happening in that first week in April, what happened on April 2^nd with the announcement of reciprocal tariffs was that was well worse than what was expected going into it. And the setup for the market at that time is one of a pretty decent amount of complacency. So that setup meant in the face of worse than expected news, you had that additional just crush in the market, and not just equities imploding, but you saw the spike in bond yields, you saw the weakness in the dollar. For a week there, you know, our markets were acting like an emerging market, not a developed market like the United States. Fast forward, it’s only a week later to April 9^th, when in the morning the markets were absolutely getting crushed, and then you had what was really just incrementally positive news with the 90-day delay of those reciprocal tariffs. But the setup at that time was one of washed-out sentiment, washed-out breadth, a market that was way oversold. So you get this incrementally better news, and that was the launch point.

Then along the way, I think what this market has been defined by and really has fingerprints on would be from the retail trader. And that’s distinct, Mark, from individual investors. It’s a narrower cohort or category. Think of it as the younger traders that sort of grew out of the pandemic era, very much the buy the dip mentality. And their fingerprints have been all over this, move off those early April lows. When you look at categories within the market of what the best performers have been, there’s a Goldman Sachs basket that’s actually called Retail Favorites, one of the best performing segments of the market from that April 9^th intraday low. Same with most shorted stocks, the meme stocks, non-profitable tech, crypto-tied securities. Again, retail traders, fingerprints all over this.

Interestingly, obviously, they have been right, and it’s sort of forced some repositioning on the part of institutions. I would say institutions at those early April lows were positioned, and had been positioned, rightly so, somewhat risk-off. Now they’re back toward risk-on, but in between neutral and risk-on.

So I’d say the setup right now is one of complacency again. I think the market has some kind of top heavy feeling to it, but I would feel more concerned if the institutional crowd had gone kind of hog wild into the risk-on sort of category much like the retail traders have. So that’s how I think about the last couple of months.

MARK: So kind of looking forward, QTs done, and we’re going to start to get earnings, companies releasing their earnings reports. Those are sort of backward-looking, but they’ll be giving guidance, hopefully some guidance on what they’re expecting going forward. What will you be listening to as you start looking at those transcripts?

LIZ ANN: Yeah, so it’s been an interesting year so far because first quarter earnings were about double what the expectation was at the start of earning season. At the start of the first quarter reporting season we’re about 8%. When all was said and done, it was almost double, at about 15%-and-change. But there’s been no extrapolation on the part of analysts to estimates for the second, third, and fourth quarters. Those have generally been trending down in positive territory in an absolute sense, but trending down. So here we sit on the cusp of the start to second quarter earning season. The consensus estimate is for about 6% year-over-year growth, which would obviously be a major deceleration from the 15% that we saw in the first quarter. But again, what I think may happen is we find that analysts have set the bar too low. In addition, we’ve had the ongoing weakness in the dollar, which all else equal, tends to be a support to S&P earnings, given that about 45% of top line growth comes from overseas sources. So even looking at the aggregate of S&P companies, even those that aren’t multinational in nature in terms of the revenue source, a weaker dollar tends to be a positive for earnings. So that could be the setup heading into second quarter.

But what I think will be more important is the commentary from companies. We’re starting to finally get more meat on the bones in terms of tariffs-related impact on pricing not just power, but pricing plans, companies talking about whether they plan to eat any of it in profit margins or plan to try to pass on higher costs, just what the plans are for companies as they navigate. What we also should know, by July 9^th, which was the point at which the delay of the reciprocal tariff ends, and ostensibly we’ll get some sort of an announcement either, ‘Okay, those tariffs are going back in place or we’re going to extend them further.’ So I think it’s the outlook part of these conference calls that arguably is more important than what is reported in second quarter.

MARK: So last question for you Liz Ann, and then we’ll bring Collin in to talk a little bit about the Fed and fixed income. How would you suggest people think about positioning their equity portfolios given your outlook?

LIZ ANN: So I don’t know how many trading-oriented folks there are on this call, so I apologize, but I think the terminology is somewhat easy to understand. There’s terminology around ‘I would fade’ or ‘I would lean into.’ So we’ve seen kind of a low-quality bias toward what has been working in this rally off the early April lows. I mentioned it in the form of the meme stocks, and non-profitable tech, and heavily shorted stocks, you know, higher volatility stocks doing well. I think that’s what you want to fade. I think that’s where you maybe want to take some risk off, and lean more into higher quality. So lower beta, lower volatility, stronger balance sheets, profitability, visibility on a going forward basis. Those were not the kinds of stocks that have done well. They’ve done well in an absolute sense, but they haven’t been the relative outperformers.

So I think some adjustments could be made where you trim back maybe any outsized exposure to the lower quality areas while maybe adding into those higher quality areas. And that tends to serve as a bit of a ballast if indeed we get some sort of negative catalyst, even if it’s incremental, and the market goes into another pullback phase in light of what the setup is right now, which, as I mentioned, is one of a bit of complacency.

MARK: Thanks, Liz Ann. Collin, let’s bring you into the conversation. What’s your Fed outlook, given that they’ve updated some of their projections? The median dot-plot still is consistent with a couple of rate cuts between now and year-end. What are your thoughts?

COLLIN MARTIN: We still think the Fed will cut rates later this year, probably one or two more times, but it really is going to be highly data-dependent. And the Fed is in a pretty similar situation. You know, two or three weeks ago we got the most recent Fed meeting. If you look just at median projections, it might not suggest there was much of a change in terms of what the committee is thinking, but if you dig a little under the hood, you’ll see that there actually is a wide dispersion of views. After the meeting, you know, all eyes are kind of on that dot-plot, and what’s the median projection for the 19 officials about how many cuts they project by the end of the year, and it was unchanged at two. That’s where it was at the end, at the March meeting as well, but there were nine participants, nine committee members who were projecting one cut or less. So there really is this wide dispersion. So even though the median suggests that we could see those two cuts, we expect kind of a lively discussion going forward because there is a relatively large number of committee members who don’t see the need to do anything.

And if you look at the Fed projections, that really ties into the Fed rate projections as well. And what was most important to us was the upgraded view of inflation by the end of this year, where Core PCE, which is one of the Fed’s preferred inflation gauges, was revised up to 3.1% by year-end of this year. So if you just take that at face value, that doesn’t really suggest the Fed needs to do much because that’s still well above the Fed’s target.

Powell in his press conference and in comments since, including today, has highlighted that the outlook’s very uncertain because of the tariffs and the tariff overhang. Just today, he said absent those tariffs, the Fed probably would have cut rates, or they would be more open to cutting rates going forward. But the idea that some of these price increases could get passed to the end consumer is weighing on their outlook a little bit, and they’re maintaining their wait and see approach.

I think that’s pretty appropriate right now. If we look forward to the July meeting, it seems highly unlikely that they do anything. The labor market has been really stable over the past handful of months and quarters. The unemployment rate, which is really just one piece of the puzzle, it’s hovered between 4% and 4.2% for 13 straight months. I mean, that’s remarkably steady. There’s some cracks here and there that suggest there could be weakening down the road, but for now it’s in a pretty good place, and with inflation still a bit elevated, there’s really no rush to do anything.

So as Powell says, they’re waiting to learn more about how the tariffs are going to play into the economy and the inflation outlook, but for now there doesn’t appear to be a rush to do anything.

MARK: And yet even kind of given that backdrop, treasury yields kind across the board have been coming down recently. What do you think is driving that?

COLLIN: Well, I think it is based on expectations of cuts, even though the Fed is kind of talking about the idea that they can be patient. I think there’s two things in play here that have pulled down rate cut expectations in the Fed Funds Futures Market, meaning market-based expectations, and that’s pulled down the level of short-term treasury yields as well. I think one is the idea that we’re already starting to hear chatter about a new Fed chair. I mean, the idea that President Trump has been very outspoken about his views on Powell, that’s widely known, but the idea that we’re starting to hear more about a new Fed chair, and the idea that this Fed chair is… if we’re going to say are they more likely to cut rates or raise rates, I think it’s clear that they would be more likely to cut rates. I think that’s weighing on the market a little bit. I think that’s part of the reason why we’ve seen rate cut expectations ratchet up not just for this year, but also in 2026.

But we also are seeing some things in the economy. You know, even though inflation is elevated, we’re seeing a dichotomy between goods inflation as the result of tariffs, and services inflation, where we are seeing slowdown in consumer spending. Last week, we got updated PCE data and real personal spending data, which takes into account price increases and inflationary impact, and it declined by three-tenths of a percent. So it seems like the consumer, while maybe not deteriorating significantly, might not be as strong as it’s been over the past handful of quarters and years.

So I think that’s weighing on the market as well. Mark, as you mentioned, that’s pulled down short-term treasury yields. We’ve seen a decline in more short-term yields than long-term yields, and it’s resulted in a more steep yield curve, which makes sense. Short-term yields are more related, more correlated to near-term changes in Fed policy. So we’ve seen that happen with the two-year treasury now down to the 3.7- to 3.8% area.

MARK: So let’s talk about the… you mentioned short-term yields. Let’s talk about the outlook for the longer part of the yield curve. Part of that, as you mentioned, is influenced to a certain extent by Fed policy, but also, it’s been influenced by the term premium. So how do you think those… which is more important right now, and what’s your outlook?

COLLIN: Well, they’re all pieces to the puzzle, Mark, but we think that even if the Fed goes through with rate cuts this year and beyond, we think it should have more of an impact on short-term rates than long-term rates. We think that the term premium, which is the extra yield that investors earn for long-term yields relative to holding short-term yields based on the expected path of Fed policy, I think that might remain elevated given all the trade policy uncertainty. I think budget concerns with everything going on in Washington right now could be weighing on the market. It hasn’t mattered over the past few days, as we’ve seen long-term yields fall a little bit. But we do think that it’s possible that those budget concerns and the idea that our debt will continue to grow over the next decade or more means that we might need to attract more and newer investors to lend to us, and that might mean yields need to stay elevated for the time being.

We don’t expect long-term yields to surge from here. That’s a concern that we hear about a lot, but we don’t share that concern. We’re not worried that rising deficits and debt levels are going to pull long-term yields up to 6-, 7-, 8%, but we think they can keep them kind of where they are now, maybe in the 4-1/4- to 4-1/2% range, even in the face of those rate cuts just because of the idea that we might need to attract new buyers there.

So we expect the yield curve to continue to steepen where we’ll see long-term yields kind of trade in the range, but we do expect short-term yields to ultimately trend a little bit lower.

MARK: Last question for you, Collin, and then we’ll bring Michelle in. It’s really a two-part question about strategy. Where is the right spot to be on the yield curve, and where do you stand from a credit standpoint?

COLLIN: So our main tenets of investing right now are intermediate-term maturities, so that’s the first part of your question, and high-quality bonds. So on the yield curve part, we like intermediate-term maturities. When we say intermediate-term, I mean, that can vary based on every individual investor’s goals and objectives, but that means probably slightly longer than what a lot of the holdings that our clients and your clients probably have. So not just in short-term investments. Because if you’re too short term, say, in money market funds or treasury bills, you’re just opening up the door to reinvestment risk even more if those rate cuts do come to fruition. And if the Fed Fund’s Futures Market is right, we could see two or three rate cuts this year, and maybe a couple more by the end of next year. So for investors who are kind of enjoying short-term yields near 4% or so, maybe we see them closer to 3% over the next 12 months. So that’s a real risk.

Now, on the flip side, we don’t suggest investors take too much interest rate risk because we do think those budget concerns and rising term premium, that could result in long-term yields moving modestly higher. We’re not worried that they’re going to surge, but we think they could move modestly higher. And if you have very long-term bonds, even a small increase in yield can pull their prices down pretty sharply. So intermediate-term maturities, we think that’s the sweet part of the yield curve.

In terms of credit quality, we’re maintaining our up in quality bias for two main reasons. First, just the idea that you don’t need to take too much risk to get what we think are attractive yields, I think is point number one. If you can earn yields of 4-, 4-1/2%, maybe close to 5%, if you take a little credit risk, say, with investment-grade corporate bonds or investment-grade munis on a tax-equivalent basis, we think that’s really attractive considering where we’ve been over the past 15 years or so.

And then number two, you’re just not being rewarded with high-yields when you are taking on more risk. So an area I focus on a lot is high-yield bonds or bank loans, bonds issued by sub-investment-grade corporations. The average spread or the yield premium that high-yield bonds offer over comparable treasuries right now is less than three percentage points. So if you look at the average yield of a high-yield index, you might see average yields around 7%. That might seem attractive, but so much of that yield is actually driven just by the level of treasuries, and not by the extra yield for taking on that credit risk. And we found that when you invest in high-yield bonds with spreads so low, you know, sub 3% or so, the likelihood of outperformance relative to treasuries is very slim. So over the next 12 months, it will be really difficult to outperform treasuries with spreads where they are.

So we don’t suggest investors take too much credit risk right now. There might be opportunities down the road. If we do see growth slow a little bit, or if we get some sort of market volatility, or risk off event, and we see spreads move up a little bit, that might present an opportunity. But for now, we’re sticking with our intermediate-term up in quality bias for fixed income investments.

MARK: Thanks, Collin. Michelle Gibley, welcome to the show. A couple of questions to you about European stocks. So strong first half of the year. Do you think they’re expensive at this point or do you think there’s a longer term growth story there that means this rally could continue?

MICHELLE GIBLEY: Yeah, I think there could be a longer-term growth story. We’re seeing growing optimism in Europe. And the America-first policies in the US are forcing countries to take steps to support their economy, steps they may have avoided before. We’re seeing this particularly in Germany. Germany previously had a black zero policy, which meant they couldn’t have any fiscal deficit. Now they’re easing up just very little, but they’re easing up on that. And the thing is, Germany has the ability to spend. After being so fiscally conservative for years, their debt-to-GDP is just half that here in the US. And so there’s optimism that growth could accelerate next year. They’re talking about maybe a trillion dollars in spending over the next 10 years, which could add 1-1/2% to growth every year for the next 10 years.

And we’re seeing businesses start to be more optimistic. The Expectations Index and the Business Climate Index is at a two-year high for consumers. Unemployment is at an all-time low. Inflation just came in, preliminary number for June, 2.3%. And economic data continues to beat expectations. And importantly, the US, the policies here may prompt the Eurozone to strengthen its union and pursue common debt issuance, and maybe also deregulation that improves its competitiveness. And I just love the saying that Liz Ann talks about, better or worse matters more than good or bad. And people like to talk about, ‘Well, the Eurozone grows slower. Why would I want to invest there?’ Well, things are getting better, and that’s the reason why.

If we look at valuations, back in December, the Eurozone was trading at a 40% discount to the S&P 500. That’s much greater than the 20% average. And expectations were very low. As I mentioned, growth is coming in better than expected, and earnings are being revised higher. So if we look at the valuation for the MSCI EMU Index, that’s the Eurozone. It’s at 14.4 times next 12 months earnings. That’s just slightly higher than it’s 13.9 average. So even though it’s up almost 20% this year, the reason that it’s not too expensive is because earnings are being revised higher. And typically the Eurozone does get a discount because of the differences in sector weights. It has a lower weight in tech and higher weights in industrials and financials, which tend to have lower valuations.

MARK: Thanks, Michelle. July 9^th is an important date next week, especially with respect to tariffs. So tell us a little bit about why it’s important and then how do you think countries are going to start to react as that date approaches?

MICHELLE: Yeah, I think if we take out the sector-specific tariffs, things like autos, and steel and aluminum, July 9^th is the day that the 90-day pause on those reciprocal tariffs, the ones announced April 2^nd, end. And so if there are no new trade deals or new executive orders to extend the pause, the tariffs are set to rise from that 10% across the board to much higher levels. Because US trade deals typically take 18 months to sign, those 90 deals in 90 days was probably unrealistic. So we’re likely to see a flurry of activity, we’ve already seen a wide range of rhetoric over the past week, but there are signs that the Trump administration wants to make deals. Even last night, the White House said they might be seeking in phased-in deals and agreements in principle. So I think that there could be some flexibility to get a win. And remember that the UK and China deals were thin on substance, yet were heralded as big progress. So many countries, but perhaps not all, could see the tariff pause extended past July 9^th.

MARK: And then one question before we open it up for live questions. I wanted to get your thoughts on India. It’s pulled back this year after a strong performance in 2024. What’s the outlook?

MICHELLE: Yeah, India could actually be a trade war beneficiary as it has one of the largest tariffs rates in the world. And so if India decreases its tariff rate by 1%, it could boost its GDP by half a percent. Additionally, India has grown as a destination for manufacturing. They’re reducing red tape, and it’s low cost to manufacture there. But there’s a limit on how fast that shift can happen. We’re seeing India continue to be top of the list for a trade deal with the US, but the Trump administration is likely to want to crack down on trans shipment, in other words, goods that are manufactured in China and then rerouted to Asian nations to circumvent those higher tariffs, maybe adding a little bit value-added to the good before continuing to ship over to the US. And the reason that the stocks have really struggled is because economic growth has slowed. Interestingly, inflation only peaked in October of last year, so much later than developed markets or other emerging markets. But now it’s below their 4% target, and so they’re cutting rates. And that could help stabilize earnings forecasts in the future. Additionally, India is one of the top three largest oil importers, and could benefit if oil prices continue to fall. India has rallied since April, but it’s still underperforming the EM Index because economic growth is still uncertain, and their stocks are still expensive at 24 times.

MARK: Thanks, Michelle. Alright, let’s take some questions here. So if you want to ask a question, just type it into the Q&A box and click Submit, and we’ll get to as many of those as we can.

Collin, let’s start with you. What is your opinion on TIPS?

COLLIN: Yeah, TIPS we think are pretty attractive right now for a handful of reasons. And I’ll try to keep it brief. I can talk about TIPS forever. When we do think about TIPS and how they can work in a client’s portfolio, usually in a small amount and relative to treasuries, we think it makes the most sense. Because they are treasuries, so they have similar risk profiles there. They’re not going to give you outsized returns unless we have super high inflation, but they can play a role, mainly because we think their real yields are attractive right now.

So when you look at a TIPS yield, it’s already inflation-adjusted. So five-year TIPS right now offers yields around 1-1/2%. Ten-year TIPS is closer to 2%. If you buy one of those TIPS individually and hold it to maturity, you would outperform inflation by those stated yields. And then whatever inflation would be over that time period would get added to that stated yield for what your nominal return would be. So a 10 year TIPS at 2%, if inflation averaged, say, 3% over the next 10 years, which is admittedly high and not our forecast, but if that were to happen, you would be looking at nominal total returns of about 5% annually, that 2% yield plus inflation. The bar for outperformance relative to treasuries is relatively low right now. We look at the breakeven rates. That’s how high does inflation need to average over the life of that TIPS for it to make more sense than a nominal. And right now, breakeven rates are in the 2.4- to 2.5% area, which is elevated relative to history, but given that inflation is elevated right now and still in that 2-1/2% range, we think they’re probably appropriate.

And then most importantly, they can make sense for your clients who really are worried about inflation because they’re one of the only investments that are actually indexed to the CPI, the rate of inflation. So if inflation surprises to the upside, they can help protect there.

So I think it can make a lot of sense just in terms of what the yields offered, but they can, I think, give a lot of investors peace of mind, knowing that if inflation were to surprise to the upside and rise even further from where they are now, you would be relatively well protected.

One last point, Mark. Just we got a question. I was talking about intermediate-term maturities before, what that means. I kind of glossed over it. Intermediate-term can be between, say, four to 10 years, on average, but that’s average. So the average maturity or duration can be somewhere in that four to 10 year range, whatever your clients are comfortable with, but that’s the range we usually talk about when we talk about intermediate-term.

MARK: Alright, thank you. Thank you, Collin. So we have… Liz Ann got disconnected for a second. We’ll see if she’s back here. Liz Ann?

LIZ ANN: I am back. Yeah, I’m back. Can you hear me okay, Mark?

MARK: Yeah.

LIZ ANN: Somehow my headset got dropped. Okay, great.

MARK: Yeah, you sound fine. Can you comment on deficit spending and the impact on GDP growth?

LIZ ANN: Well, at this point, we are still talking about the reconciliation bill working its way through Congress, so estimates are only made based on the House version. And CBO just came out, I think, today, saying now estimates are a little bit north of $3 trillion in terms of what gets added to the debt. Interestingly, CBO also came out a couple of weeks ago saying that there would be offset based on tariff revenue. I wouldn’t put a lot of value in that component. They did say that tariff revenues could equate to $2.8 trillion over the next 10 years, but that was based on what tariffs were in place as of May 13^th, and then they extrapolated that over the 10-year window. Not to make light of an uncertain situation, but I wouldn’t extrapolate tariff revenues over a 10-minute window, let alone a 10-year window. So we’re still dealing with somewhat muddy math, other than we know that this is going to add to the deficit and add to debt.

Now, what we have often touched on, certainly Collin, is that there isn’t a direct short-term relationship between the deficit or debt and interest rates. The concern is there about whether investors in treasuries are going to demand higher yields in light of needing to finance the deficit. That clearly hasn’t been the case at this point, but what long history shows, and not just in the United States but globally, as well, where there are high debt levels, is that it acts as a suppressant on economic growth. All else equal, it tends to put downward pressure on GDP, and downward pressure on labor market indicators, and also productivity. So I think that’s something with which we have to contend.

Ideally, the situation is one where you get to a point where the growth rate in debt is lower than the growth rate in the economy because then you start to chip away at the problem. The problem is that a high and rising burden of debt, especially given that the fastest growth rate within the deficit is now interest on debt, which leapfrogged defense, that whole crowding out effect I think carries a little bit more water than in the past. So we don’t worry about some sort of Armageddon imminent tipping point, but I think it’s the suppressant on growth via the crowding out effect that is the most valuable historical component of how to analyze this in the present time.

MARK: Thanks Liz Ann. Collin, this one is for you. We never hear about quantitative tightening anymore. Can you update us if this is still happening? And by that, I mean the rolling off of assets from the balance sheet, or just selling bonds from the Fed’s balance sheet?

COLLIN: Yeah, we don’t hear about it too much because it’s not really happening too much. Technically, definitionally, it is happening, but it’s very much in the background. Quantitative easing, which I think a lot of people are familiar with and makes more headlines, is when the Fed buys bonds to lower interest rates, and then QT, or quantitative tightening, is when they allow a lot of those bonds to mature off their balance sheets, and that means other investors need to then go buy those bonds. The Fed basically, it started slowing its QT process over a year ago, I believe, where they come out with the caps to how many treasuries and mortgage-backed securities are allowed to roll off on a given month, and if that cap is hit, they take the remainder and reinvest in new treasuries. The mortgage-backed securities portfolio is still rolling off because the Fed doesn’t really want to use mortgage-backed securities as part of its tool again going forward. They did it to help the housing market given the pandemic. They don’t want mortgage-backed securities to be really part of their portfolio going forward. So they’re letting those continue to roll off as they have. The problem is it’s just going very slowly because no one is really prepaying any mortgages right now, given the high level of interest rates.

For treasuries, there is a $5 billion that they’re allowed to revest… or allowed to mature each month. The rest gets reinvested. So that means they’re really just maintaining their treasury portfolio, with the exception of 5 billion per month that they allow to roll off. Now, that in and of itself, has made some headlines recently because that means that every maturing treasury they have, with the exception of 5 billion that they allow to mature, gets reinvested in the market. Those are not net purchases, they’re just maintaining the size of their balance sheets. But I’ve seen headlines before about the Fed being active in treasury auctions because they are reinvesting to maintain, and we’re seeing some big numbers, where the Fed is buying billions of dollars worth of treasury notes at auction. That is not quantitative easing. There’s been some misleading headlines that suggest the Fed is embarking on QE again. That’s not the case. They’re just maintaining the level of treasuries they have on their balance sheet right now with that 5 billion exception, with the plan to have that moderate just over time.

MARK: Thanks, Collin. Let’s see, this question, I’m going to send this to both Michelle and Liz Ann. Maybe Liz Ann, we’ll start with you, and then Michelle can chime in. When do you expect the impact of tariffs to kick in and who will be affected most, for example, which industries?

LIZ ANN: So obviously, in terms of… and for the second part first, the industries most impacted would be those that import the most goods from overseas sources. So that’s a lot in the retail space, consumer goods companies, but then you also have many of the inputs like steel and aluminum that feed its way into the auto industry, feed its way into the energy industry.

In terms of when the impact is going to be felt. The short answer is I don’t know when the full impact is going to be felt because we’ve got that key expiration deadline of the delay of the reciprocal tariffs on July 9^th, and then it’s a function of what happens then. We know that the average effective tariff rate right now is about 15%, which where we are right now, that’s higher than anything we’ve seen in the last 100 years. It even exceed Smoot-Hawley of the 1930s era. If the reciprocal tariffs were to kick in, they were not continued to be extended, at the same time you got the now proposed sectoral tariffs of areas like pharmaceuticals, the proposed or threatened additional 50% tariffs on goods being imported from the European Union, that average effective tariff rate goes from 15% to 35%. That would result in an epic hit to the economy with a timing that would be a little bit more near-term if the decision leading into or on July 9^th is not to extend the delay of those reciprocal tariffs.

In terms of the price impact, only in the last few weeks are we getting news more specifically from companies as to their pricing plans, price increases that are either announced as being tied directly to tariffs, or in some cases announced with more generic language, maybe not to frustrate the administration. So I think at least a decent chunk of the impact is still ahead of us, not behind us.

MARK: Michelle, what are your thoughts?

MICHELLE: Yeah, I’d agree with that. I think we also had the front-running of pulling in purchases and shipments before the tariffs happened in March. And even with China, when the 145% tariff was on and then rolled back, it took several weeks for the ships to get into position from China to come to the US. So those goods just started arriving the third week of June. And also, we do have increased tariff revenue coming in, but we could see more coming in the future. We’ve already seen autos and auto parts retailers impacted by those higher tariffs and pull forward of purchases. So now they’re seeing a little bit of slowdown.

In terms of other countries, there are some countries that could be made examples of, and remember that the US importers are the ones that pay, but it could hurt the exports of these other countries. So for instance, Japan appears to be having some difficulties in negotiations, and part of the reason is they want lower tariffs on autos, steel and aluminum as well. In the EU, pharmaceuticals are 25% of their exports to the US, and they want lower sectoral rates. So we could have some of these countries maybe revert back to the high levels on July 9^th, but even if that happened, we’ve seen in the past tariff levels have escalated and deescalated quickly. Remember that for Canada and Mexico goods that were compliant with USMCA, that tariff ended after just 13 hours. Tariffs on Colombian goods ended after just nine hours. And so I think that we could have various short-term impact on the market and a reversal of those high tariffs if that happened.

MARK: Thanks, Michelle. Collin, this one is for you. ‘What is Collin’s outlook for emerging market local currency bonds?’

COLLIN: Yeah, we think there can be a place for EM, you know, with some caveats. On the one hand, if we’re worried about growth potentially slowing, that’s a bit concerning for emerging market economy. So, you know, what’s the risk premium that you’re being offered? And when we look at emerging market local currency debt, it’s a very nuanced answer because if you look at just yields from a straight index level, they’re not super attractive. Bloomberg has a local currency EM Index, and the average yield is close to 3-1/2%. That’s lower than the US Ag. But a lot of that has to do with a growing share of Chinese debt, which has very, very low yields pulling it down. Now, there probably are opportunities more maybe in a more active strategy that focuses on other economies, other governments that maybe offer higher yields. If the dollar were to continue to decline, that would be a boost. I mean, that’s a benefit of international local currency investing. A weaker dollar helps you from a currency standpoint.

So a little risky from a credit risk standpoint, but there probably are opportunities just for consideration, you know, in moderation maybe to consider.

But I think, Mark, a bigger question and we got something along the lines. I’ll read the question. ‘Should investors be investing with a weakening dollar in mind?’ I really like how that’s phrased. I think the answer is yes. For years, we haven’t… my team in SCFR, the Schwab Center for Financial Research, hasn’t focused too much on global bonds just because we didn’t see too much of an opportunity. The US generally offers higher yields than most other developed market economies. So if you’re an income investor, the income opportunity wasn’t too attractive. And when you look at where the currencies have been going over the past decade, the dollar has been strengthening or strong for most of that time. I mean, there’s been volatility, there’s been ups and downs, but we’ve generally been in a strong dollar decade. So it hasn’t been super attractive to consider international bonds, local currency, the international bonds outside of just a diversification benefit standpoint.

I think that’s changed a little bit today. The yield advantage that the US offers is still there, so you’re still generally accepting lower yields and lower income payments if you’re considering other developed market economies. But we do see room for the dollar to decline a little bit from here. You know, if the Fed does in fact cut rates as much as the markets are expecting, we’d see narrowing interest rate differentials. That makes the case for more of a weaker dollar. And just the idea of all the trade uncertainty and trade policy decisions that are going on right now, I think that can weigh on investor appetite for US-based assets, US dollar-based assets.

So I think we could see a weaker dollar over the short term. Now, it doesn’t mean it’s going to lose its reserve currency status, that’s not a concern of ours, but we do think it can decline modestly from here.

So we’re not suggesting investors kind of dive headfirst into international bonds, but it’s been an area that we know a lot of investors just haven’t really considered much over the past decade, and it’s probably time to shift that thinking a little bit, and it’s making a lot more sense now than it has been over the past 10 years.

MARK: Thanks, Collin. Liz Ann, a couple of questions for you. Does an equal-weight index make sense now as the S&P 500 gets more concentrated? And then a related question here, any forecast for small- and mid-caps?

LIZ ANN: Yeah, so I think that there is some merit to equal-weight over cap-weight, although the concentration problem is not as acute as it was, say, last year and the year before. You have seen a bit more dispersion. The winners from a sector perspective are in areas like industrials this year, which is the best performing sector. So you’re not really seeing that bias in the growth trio of sectors—tech, communication services, and consumer discretionary. In fact, consumer discretionary is the worst performing sector this year. You’ve got four out of the Magnificent 7 group of stocks underperforming the S&P this year. Only three are outperforming. So a bit more dispersion, and some connectivity between fundamentals and prices, which does at least come close to leveling the playing field between equal-weight and cap-weight. I think there’s also ways without making a full sale switch from, say, cap-weighted investments to equal-weighted investments, is to also affect a similar shift by just doing a rebalancing strategy that eliminates some of that concentration, as opposed to having to make the decision to go fully into equal-weight.

As far as small- and mid-caps, it’s a very broad question, and I think you have to be careful about monolithic decision-making as it relates to stocks down the capitalization spectrum. If you look at, say, the Russell 2000 Index of Small Caps Stocks, a really, really wide array from a quality perspective. Still more than 40% of that index is some combination of non-profitable and zombie companies, meaning they don’t have sufficient cashflow to even pay the interest on their debt. So I think what’s important to do when going down the cap spectrum is not make monolithic decisions but move up the quality spectrum, avoid those areas of zombies, non-profitable, weak balance sheet, low interest coverage companies. And that’s where you’re seeing the weakest forward looking profiles too. You’re not seeing an expected lift in earnings, where you are up the quality spectrum. So I think that’s the way to make that differentiation happen within the small- and mid-cap space is use that factor-based approach, avoid the lower quality, and lean into the upper quality end.

MARK: Thanks, Liz Ann. Let’s see, Collin, here’s a question for you. I think this is a Fed-related question here. Is it the chairman or the collective members that decide rate cuts?

COLLIN: That’s a good one, especially in the environment we’re in or will be in the next 12 months or so. It is a committee, but the chair, I’d say, has an outsized role. We think the three most important committee members are the chair, the vice chair, and then the president of the New York Federal Reserve, as he’s a permanent voting member as well. So they tend to matter the most.

If I’m reading between the lines, I think the question is if we get a new Fed chair who is very enthusiastic about cutting rates aggressively per comments from the Trump administration, will the rest of the committee be on board with that? And I don’t know the answer to that question. I think it’ll be interesting to see what happens over the next 12 months or so, because even after Fed Chair Powell’s term ends, there will probably be a handful of months before the new chair is actually in place.

So it is a committee-based approach. There’s no shortage of strong opinions of the committee members. They’ve all been doing this for a while and know what they’re talking about. But it will be interesting to see how this plays out over the next handful of meetings when there is a new Fed chair in place, and if they have views that are very different than what most participants are expecting.

MARK: Thanks, Collin. Michelle, can you comment more about the US reserve currency status and why or why not investors should be concerned about that changing?

MICHELLE: Yeah, as Collin mentioned, we believe the dollar could gradually decline, but it doesn’t mean that it’s a crisis. The dollar has cycled between periods of strength and weakness in the past. And if you think about what is the alternative? And there’s not a lot of great alternatives, and the US treasury market is the largest and most liquid in the world, but we could see a period of weakness in the dollar after a decade of strength.

MARK: Thank you, Michelle. And let’s see, Liz Ann, this one’s for you. ‘Liz Ann mentioned quality and low volatility. Are there two or three measures that investor can look at to get a quick picture or a snapshot of each, for example, standard deviation, forward PE, debt-to-equity, etc.?

LIZ ANN: Yeah, so high-quality factors that we have been emphasizing include those that are balance sheet-related, so fairly low debt, high interest coverage, strong free cash flow. And then there are more in terms of just market activity that are high quality, so lower beta, lower volatility. You could also have more value-oriented factors that would be up the quality spectrum, so stable dividend yields. From a growth perspective, there are quality factors, so positive earnings revisions, positive look-back in terms of earnings. So lots of sort of a broad category of quality, but you can find them within the balance sheet-type of factors, value-oriented factors, and growth-oriented factors.

MARK: Thank you, Liz Ann. And why don’t we wrap it up with one last question for each of you? What’s the one thing you want people to take away from your thoughts today? Collin, why don’t we start with you then Michelle, and then we’ll give Liz Ann the final word. So Collin, you’re up.

COLLIN: I’ll kick it off with I’ll just repeat my point about reinvestment risk. Now, there’s a lot of uncertainty about what the Fed will or won’t do over the next handful of meetings, but expectations have shifted pretty dramatically about the magnitude of rate cuts over the next handful of meetings. And that means that that reinvestment risk is real. So if you have clients that are in T-bills or money market funds, it seems highly likely that the income earned on those will continue to decline over the next 12 months or potentially beyond. And I just think it’s an important message to talk about when having those discussions because if we go back 12 months or so, we were talking about that risk even with an inverted yield curve. And we know a lot of investors, even ours here at Schwab, continue to hold large amounts of short-term investments. And here we are today where they’re earning yields of 100 basis points less than what they were getting last year. So we want to make sure that clients and investors are aware of that risk, and highlight that even with the modest decline in yields we’ve seen over the past few weeks, they’re still at the kind of high end of the range we’ve seen over the past 15 years or so. So the opportunity hasn’t disappeared.

MARK: Thanks, Collin. Michelle, what are your final thoughts?

MICHELLE: Yeah, I think that many investors might be underweight international after it underperformed for the past 15 years. And a lot of the outperformance for the S&P 500 was tied to tech, and it’s important to remember that tech doesn’t always outperform. Additionally, a weaker dollar is a benefit, currency exposure is a diversification benefit. So investors might want to be unhedged. And remember that the mirror of a weak dollar is a stronger foreign currency. So let’s say, a stronger Euro translated into dollars means more dollars, which boost returns for US investors. And if the Eurozone continues to outperform, it could reach a three-year rolling outperformance by the end of October. And we’ve seen in the past that three-year track records tend to attract more inflows, which could keep the outperformance trend going. So it’s likely not too late to add international to the extent that portfolios are underweight.

MARK: Thanks, Michelle. Liz Ann?

LIZ ANN: Yeah, so Mark, there is, I think, almost too much use of the word ‘uncertainty’ to describe the backdrop. I often chuckle at the ‘market hates uncertainty’ line, as if there’s ever certainty. So I think uncertainty is just part and parcel of investing. And whether it’s the economic outlook or the market outlook, I think the ‘un’ word that may be more applicable in this backdrop is ‘unstable.’ And given the instability not only in policy, but how we get information with regard to policy coming via, say, social media post makes it really difficult to gauge, at least in the short-term what those announcements are going to be, whether it’s on the tariff front or the budget front. What we can do is gauge the so-called setup. So what are the background conditions in the market? Does it establish more potential upside because things are washed out or some potential risk because complacency has built back in. And I think this is an environment where there’s complacency that is kicked back in courtesy of the move back to all-time highs off those early April lows.

So that setup means that we might be fine. I think the sort of pain trade based on positioning is probably still up from here. But there’s probably some vulnerability too, to the extent you get, even if it’s incrementally, any kind of worse news. Which is why one way to think about positioning is to sort of fade the low quality, which has been characteristic of a good chunk of this move off the early April lows and snuggle up a bit more to the quality end of the spectrum within equities. And that gives you a little bit of that stability if you get a pullback, which could happen via an announcement, that’s very difficult to try to gauge in advance.

MARK: Alright. Thank you, Liz Ann. Thank you, Collin Martin and Michelle Gibley.

If you would like to revisit this webcast, you can do so by taking a look at our follow-up email that will be sent shortly with the replay link. To get credit, to get CE credit, you need to watch for a minimum of 50 minutes, and you must have watched it live. Watching the replay doesn’t count. To get CFP credit, please make sure that you enter your CFP ID Number in the window that should be on your screen right now. Schwab will be submitting that credit on your behalf to the CFP Board. 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 will be August 5^th. Our speakers will be Kathy Jones, Michelle Gibley, and Kevin Gordon. Until then, if you would like to learn more about Schwab Insights or for other information, please reach out to your Schwab representative. Thanks again for your time, and have a nice day.

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