ALEXANDRA SEMENOVA: Hello, everyone. Happy Tuesday, November 3^rd . Thank you so much for joining us today, and welcome to Schwab Market Talk, our monthly webcast with advisors designed to answer all your questions on markets and the economy. It’s certainly been an eventful time for investors, and it’s also election day, so we have a lot of ground to cover. I’m Alexandra Semenova, Financial Insight Strategist here at the Schwab Center for Financial Research, and I’m pleased to be your moderator today.

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We have our brilliant team of SCFR strategists here to address all of your questions: Liz Ann Sonders, Chief Investment Strategist; Cooper Howard, Director of Fixed Income Research and Strategy; Chris Ferrarone, Head of Equity Research and Strategy: and Michael Townsend, Managing Director of Legislative and Regulatory Affairs.

Lastly, before we jump into the conversation, I’d like to highlight a few helpful resources in the webcast console. In the top right corner, you’ll find a link to the quarterly Investment Outlook for advisors. In the bottom right corner, you’ll find additional materials, including a link to the latest chart book.

It is election day and there’s really no better person to kick us off with and help make sense of it all than our very own politics and policy expert, Mike. Mike visited a whopping 38 cities since Labor Day to talk to investors. And Mike, here we are after all of the discussion and speculation. It’s actually election day, and early voting turnout set a midterm record of 57 million ballots cast, reflecting just how consequential today is. So after all of this, what is your final take on what you expect will happen today, and what will you be watching for tonight as the returns come in?

MIKE TOWNSEND: Well, sure. Thanks, Alex. And hi, everybody, from Washington. Certainly, my Super Bowl day has finally arrived here. I’m pretty excited.

In terms of what I expect to happen, Democrats seem all but sure to win the majority in the House of Representatives. I think the question is just how large that margin will be. I think the floor is probably around 225 seats, so something like a 225 to 210 majority seems likely. There are a lot of analysts out there who are looking at something more like 235 seats for the Democrats, and perhaps even a few more than that. I think the likelihood is that Democrats have a solid majority that gives them some wiggle room on tough votes where maybe a few of the Democrats need to vote the other way.

I think the big focus tonight is on the battle for the Senate. I’m giving Democrats the edge to win a narrow majority, but it is far from certain. There are currently seven Senate races that appear to be genuine toss-ups. They’re polling within the margin of error. And while Democrats are slightly favored in most of those, and the trend has been in many of those kind of going towards the Democrat candidate, just a little bit of a miss on the polling or a big election day turnout for Republicans could flip several of those races in the Republican’s direction.

As far as what I’m watching, let me just highlight a few things to watch tonight that may give an early indication about whether we’re talking about a blue ripple, a blue wave, or a blue tsunami. First polls close in Indiana and Kentucky at 6:00 PM Eastern Time. Each has a close House race in a district that President Trump won by more than 15 points in 2024, Kentucky’s sixth district in the Lexington area, Indiana’s fifth north of Indianapolis. If the Democrat wins or is close in either of those two seats, that could signal a big night for Democrats. At 7:00 PM Eastern, watch South Carolina’s Senate race, where Republican Darlene Graham, the sister of the late Lindsey Graham, is in a tough race to win the seat for a full term. There are also three close races for the House in Virginia that could be notable. Virginia is one of those states that counts really quickly. Ohio polls close at 7:30 Eastern. That Senate race is another key one to see if Democrat, the former Senator Sherrod Brown can pull out a win there. 8:00 PM Eastern, you get a whole slew of states closing, but I’d particularly watch House races in Florida and Pennsylvania, and that Senate race in Maine, which is going to be really, really competitive. And then finally, 9:00 PM Eastern, we get polls closing in the most important Senate races—Iowa, Kansas, Michigan, and Texas. If Democrats win three of those four races, it’s over. Democrats will have the Senate majority.

So that is what I’m kind of looking as the early half of my night, and I just wanted to share those perspectives, so that as you’re getting all this information in, you’ve kind of got a few things to really focus on.

ALEXANDRA: So given your expectation, Mike, that the outcome is likely to leave Washington even more divided, does a divided government still have its market-friendly reputation? Do you expect that or could gridlock become a bigger risk when deficits are such a concern, and when monetary policy is restrictive?

MIKE: Yeah, Alex, I think this is a really interesting question. We know historically markets generally like divided government because it means that neither party can overreach, and compromises are going to have to be struck. And frankly, markets just like the fact that the election is over because having the result removes a big source of uncertainty. The S&P 500 has been up six months after every midterm election since 1974. But I think you’re right to point out that gridlock is becoming a bigger risk because it tends to mean that Congress is just not solving big problems. We’re already seeing the global bond market reflecting more concern with rising debt levels, not just here in the United States, but France, Japan, Germany, other places. And I don’t think there’s much optimism that a divided Washington is going to make much progress on addressing the debt or the budget deficit over the next couple of years.

The biggest market moving thing looming in 2027 is going to be the debt ceiling fight. We don’t know exactly when that will happen, but we know it’s coming, and that’s always a really difficult one to get the two parties to agree to, and it’s something that typically sparks market volatility.

So I do think that there’s more concern this time around that Congress just isn’t able anymore to solve big problems, and that’s going to continue, I think, to worry the markets.

ALEXANDRA: A lot of the issues that are impacting markets, from tariffs to trade to regulation, they don’t necessarily depend on Congress passing any major legislation. So if the midterms do produce a divided government, which policies with the greatest potential market impact can still move forward regardless of who controls Congress, and what should investors be watching most closely in 2027, Mike?

MIKE: Yeah, I do think we’re likely to see at least some issues where the two parties will try to work together. The Clarity Act died in the Senate earlier this fall, but creating a regulatory framework for cryptocurrency that includes some investor protections, I think that remains a bipartisan priority, and frankly may have only increased with the Binance hack a few days ago. Retirement savings, another area that typically has bipartisan support. There’s some rumblings on Capitol Hill about a SECURE Act 3.0, so I’ll be watching that. I’m also keeping my eye on whether this is finally the year that a congressional stock trading ban can pass early next year.

But frankly, I think most of the action for investors and advisors is going to continue to come from the executive orders and from the regulators. I expect the SEC and the CFTC to continue their aggressive deregulation efforts. They’ve already got a lot of rules in the queue that they’re sort of unwinding things, and we should expect more to come, particularly in an environment in which Congress is controlled by Democrats. The regulators are likely to be pretty aggressive, trying to get as many initiatives through as possible before the end of the president’s term. So I do think that’s where the action is going to be. And frankly, we’re talking mostly about deregulation, not more restrictive regulation coming. And I think that will continue to be the case over the final two years of Trump’s presidency.

ALEXANDRA: Thank you so much, Mike, for that thorough overview.

And we’ll now go to Liz Ann to break down the market implications of the election and where she sees markets in the economy going from here. Liz Ann, there’s a familiar playbook around midterm elections. There’s an expectation that regardless of who wins, clearing the uncertainty could be good for markets. According to our own data here at SCFR, since 1974, the S&P 500 has been higher six months after every midterm election, all 13 of them with an average gain of 12.4%. But given where we are today with elevated valuations, sticky inflation, uncertainty around the Fed, do you expect that the traditional midterm playbook will play out?

LIZ ANN SONDERS: Well, Alex, I would suggest that it hasn’t really been playing out this year in terms of what the pattern is. Now, I probably should start with the very important caveat that I don’t think any investor should be moving money within their portfolio around specific to a particular outcome or based on the historic playbook that we’ve got some guaranteed renewed pushback higher in the equity market by virtue of just the election ending. This has been a unique year in particular because although within midterm years, if you go back in history, the average maximum drawdown that has occurred in midterm years is 19%. So that’s close to bear market level declines. It tends to be the flattest with the biggest drawdown tends to occur in the midterm year versus the other four years. But that decline more often than not happens in the lead into the election, and then you get the rebound after that. And part of the reason for it, and Alex, you mentioned the word ‘clear.’ I’ve heard a lot of chatter about could the election be a clearing event for the market. What that’s typically suggestive of is that the election itself has been the significant uncertainty plaguing markets, and causing that near bear market level drawdown on an average basis. I would argue with the exception maybe of data centers, and the fact that they have become sort of this political hot potato, what’s been plaguing the market more recently is not really about the election. So yes, the election being in the rear view mirror just eliminates one of those uncertainties, but I’m not sure it represents a clearing event to the degree that it has in the past because it’s not really the election that has been what has plagued the market. So I think you have to be real careful.

And also you mentioned every instance post midterm election, six months following, you’ve seen a positive market. That’s also the case for 12 months following, but the range around those averages… and remember, a midterm election year is not an every year phenomenon. So you’ve got to understand that we don’t have a large sample size here, as is the case with any four-year cycle, you get a fairly big range. And in the 12 months following midterm elections where every market performance has been in the positive column, you have had a couple of years barely positive, and you’ve had a few years in addition to that that had subpar returns.

So I wouldn’t use the playbook as a map for what to do. I think there’s a lot of other forces in play right now that either have nothing to do with politics or only peripherally.

ALEXANDRA: Yeah. One of those forces, Liz Ann, is of course where monetary policy is headed from here. It takes time for interest rates to permeate the broader economy, and we’re already seeing signs of slowing in some parts of the economy. Do you think that that’s a risk for the Fed right now? With policy still restrictive, what would tell you that the Fed has already done too much, or that we’re at risk of a sharper slowdown?

LIZ ANN: So it is very premature to suggest the Fed has gone too far at this point. They’ve only hiked once. They paused at the most recent meeting. Betting odds are that they’ll hike again in December. And for now, the background fundamental conditions are very much supportive of the Fed maintaining a tightening bias, at least in the near term. And that has to do with the level of nominal growth, which more likely than not is accelerating from here, not just inflation now, but inflation expectations, the expected future path of policy picked up in a yield like the 10-year yield. So, so far, I think the stance of the Fed is in keeping with the fundamentals that tend to drive that.

There’s a couple of rubs, though, that tie into this uniquely modern period of time in which we’re living. The concern about higher short-term rates and in conjunction with maybe a higher for longer on long-term interest rates, is when you talk about leverage in the system and the cost of capital, you’re talking about financing the timeline associated with investments. You go further out the duration spectrum, and now I’m talking specific to the equity market, you’re financing a longer timeline. The thing that is different this time is that the shelf life of theme changes, narrative changes, technological changes as it relates to the AI story has condensed quite significantly. So we’ve got these metrics that are driven by, call it human time, a human time scale, yet what’s happening within AI, the winners, the losers, the theme changes, what’s working, what’s not working, leapfrogging in terms of technological advances, and who is in the leadership position have shrunk precipitously. So to me, that is a mismatch that is really important to keep an eye on in this unique environment of AI.

The lack of forward guidance might end up serving the Fed well because they’re not, or at least Warsh’s view is not to sort of map out strategy over even the medium term. So the Fed does have the ability to shift gears fairly quickly. They might just be doing it a little more behind the scenes than what historically we’ve been used to with a bit more telegraphing on the part of the Fed.

ALEXANDRA: One of the interesting features of this market, Liz Ann, that’s been really prevalent over the past year is relative calm at the index level, but these really sharp rotations underneath the surface. You’ve called that the new momentum trade, and it’s really played out again in recent weeks, as we saw investors flee tech and kind of move into other pockets of the market. What would help you distinguish whether this is a healthy broadening or if this is an increasing sign of a fractured market between tech and everything else? And how should investors position themselves in this environment where rotations are so abrupt?

LIZ ANN: Yeah, so far I think these rotations have been relatively healthy. And it happened earlier this year too, and a couple of times over the past one year, where you get a pullback in what had been the prior leadership names, you get sort of the generals retreating from the frontline, but you get enough boost from the soldiers moving to the front line. And that’s something we’re seeing even just in the last couple of weeks. I track on a rolling look back one month basis, as well as other number of months, but I’m going to cite the trailing one month period for the argument of illustrating this. Right now, you’ve got about 75% of S&P stocks have outperformed the index itself over the trailing month. Just a few weeks ago, that was down to only 17%. Another way to illustrate this sort of calm at the surface of the indexes and churn underneath is the S&P at the index level hasn’t even had a correction in terms of a maximum drawdown year. The biggest peak to trough decline at the index level for the S&P was in the February-March period of time when the index had a 9% drawdown, but the average member within the S&P has had a 27% maximum drawdown this year. It’s much more stark for the NASDAQ. The NASDAQ has actually had two corrections this year, 13% back in the February-March period of time, and we just hit another 10% drawdown at the index level, but the average member within the NASDAQ has had a 48% drawdown. So we also have a record number of stocks, 191 stocks within the S&P 500 on a trailing six-month rolling daily basis, trading with a negative beta, so moving in the complete opposite direction of the index. You’ve got the two best performing sectors year-to-date, which is energy and technology. They have a negative correlation. That’s the first time in the history, at least, that we have access to the data back to 1973, where the two best performing sectors are negatively correlated to one another. And that’s because the narratives and the fundamentals driving those two sectors is obviously quite different with energy and technology.

So I think these forces are likely to continue, but that we could persist in an environment where you get this churn in rotation under the surface, you see that help to correct excesses, be it sentiment excesses, valuation excesses, you see that rotation. I think it would take a bigger shock, a more significant catalyst that would cause more of an aggregated move down, and correlations to go up and dispersion to go down. For now, dispersion is very high. Correlations are low. This is a better backdrop for active relative to passive. Even over the past trailing one year, equal weight is handily outperforming cap weight. So there are opportunities for diversification even within an index like the S&P, where you can diversify away from the concentration that still exists by looking for opportunities in other segments of the market.

ALEXANDRA: Thank you so much, Liz Ann.

And we’ll get a little bit deeper into those opportunities for diversification with Chris. We’re going to stick here with equities. So Chris, even with the recent pullback in tech, investors still remain very heavily concentrated in mega-cap technology stocks, but the concern around enormous spending on AI, and whether companies can monetize those heavy capital outlays, they haven’t gone away. So if this is still a big risk heading into 2027, where in the market do you see opportunities today? What pockets of the equity market look good to you?

CHRIS FERRARONE: Yeah, thanks, Alex. The tech concentration risk remains quite high, and we’re at near historical peaks for the percent of market cap that’s taken up by tech, and the mega tech companies themselves are a large share of the overall index. And that’s not just in the US. We’re seeing that in emerging markets as well. And so we think that the opportunity is less about abandoning technology, and more about diversifying your sources of earnings growth. And we’ve started to see some encouraging signs of that. In fact, you just heard Liz Ann’s comment that about 70% of the S&P 500 has had positive returns in the last month or so, even as the index itself fell and there was weakness in those big cap tech names. So underneath the headline index, there has already been something of a handoff taking place, but I would say a few weeks of this leadership does not make a trend.

When we look out, and we’ve published a couple of reports focusing on this, also similar analysis as to Liz Ann, where we’re looking at sectors and industries that have very low correlations to technology—industrials, materials, financials and selective parts of healthcare, in addition to energy, which Liz Ann pointed out. And some of these sectors, industrials and materials in particular, have exposure to investment themes beyond just AI, including general infrastructure spending, manufacturing activity, defense spending, supply chain reconfiguration, which are all themes that are running underneath the surface of the AI theme. So we’re looking at a sector and industry exposure where there’s positive earnings growth, but low correlation to tech and AI. And then we can look globally as well. Europe at large has very low tech exposure relative to the US and to emerging markets. And Japan, while it does have a relatively high tech exposure, it also has a broad sector diversification and some domestically-driven catalysts. Emerging markets is a little tougher because you’ve got Korea and Taiwan, which are now the two largest countries in the market, and they are very much driven by tech and AI. So selective exposures to sectors and to countries outside of the US are how we think about diversification.

I would just say broadly, the next phase of the bull market doesn’t require the Mag 7 to collapse. For example, we don’t need to see a collapse there. A healthier outcome would simply be less dependence on that select group of really mega-cap hyperscalers and semiconductor stocks.

ALEXANDRA: Another interesting feature of this market, Chris, has been the resurgence in equity issuance. It has picked up meaningfully this year, with more companies coming to public markets. Of course, we get all these headlines about the IPOs this year and some that are still on the docket, and a lot of companies also raising capital. What does that tell you about investor appetite and the health of the equity market? And do you expect that momentum to continue into next year?

CHRIS: Yeah, that’s a good question. It’s one that doesn’t have one clear cut answer. I think the rise in equity issuance has been a sign of market health recently, but that can change quickly, and is something we’re watching quite closely. On the healthy side of things, strong issuance tells us that capital markets are functioning, and we’ve seen, especially in that tech AI space, large amounts of corporate debt issuance, and then more recently an increase in equity issuance, including IPOs.

But there’s another side to it. So companies tend to issue stock when valuations are relatively attractive and there’s strong investor demand. And the numbers that you just mentioned are unusually strong. So I think the question is not just are IPOs rising, it’s what is the money being used for, and can the market absorb the supply? And so far, we’re seeing the market become a bit more discerning both in credit markets and in equities. Consensus estimates right now expect US corporate equity issuance could roughly hit 500 to 600 billion next year alongside a large quantity of stock that’s becoming freely tradable as the IPO lockups expire.

I’d note one other nuance here, and that’s that these issuance estimates have continued to rise over the last few months, and that’s really coincided with bond yields rising and credit spreads in the AI space widening out. Companies have been tapping credit markets for funding during much of this year, even back into the start of 2025. But as interest rates have risen and those spreads have widened, the relative attraction of issuing equity has increased relative to debt. And we’ve seen many tech companies do exactly just that, in some cases trying to issue before these big IPOs because there is concern that these large IPOs can add additional supply where there’s some uncertainty about the demand there.

So I think what we’re seeing now is, again, markets becoming more discerning. In September, the IPO market was very strong, but several proposed transactions recently have been postponed or withdrawn entirely, and we’re seeing some that are being repriced lower on the back of increasing yields, higher yields, and investors becoming more selective about that.

So I wouldn’t interpret issuance itself as a flashing red light. The warning sign would be deteriorating quality, weaker companies coming public at increasingly aggressive valuations, poor aftermarket performance after following those IPOs, and a widening gap between the supply and underlying investor demand. And that’s when a healthy reopening of the capital markets, which we’ve seen this year starts looking more late cycle-type behavior. So that’s a dynamic that we’re watching quite closely.

ALEXANDRA: As you briefly mentioned, Chris, AI infrastructure spending is increasingly being financed through the bond market. At what point does the cost of funding of that build-out start to matter for equity investors? What would be your warning sign that AI CapEx is becoming a drag on free cash flow, rather than a source of future growth?

CHRIS: Yeah. Well, I think you just hit on a key thing, but I’d say generally speaking, this is a challenging question. There’s really no one thing to look at, and I’m watching the interaction between CapEx, free cash flow, and the cost of capital. Early on in this cycle, the hyperscalers could fund most of their investment internally through internally generated cash flow. That’s changed as CapEx numbers have skyrocketed, and they’re now exceeding cash flow. So the hyperscalers now, if you look at free cash flow in recent quarters, it’s negative. So these companies have shifted to become net issuers of debt and equity to finance the more recent leg of the CapEx cycle.

As we look forward, the large investment banks are estimating that hyperscaler bond issuance could run another 200 to 300 billion in 2027. Of course, that depends on rates and spreads, but this is already after credit, we’ve seen some widening of credit spreads there. I think the key test is whether free cash flow can recover as CapEx eventually moderates, and we start to see some monetization of this AI investment. But that could take one to two years from now. So the market is watching these dynamics, and they’re also more recently watching the amounts of off balance sheet commitments rise. Things like lease agreements and future purchasing commitments are all forms of credit, and the dollar amounts here are very large. In fact, they’re four times the amount of the on-balance sheet debt that we’ve seen recently. So it’s an area where the markets seem to be looking more closely.

So looking forward, a few things to watch. One is CapEx and whether it continues to rise while free cash flow keeps falling. Two, are credit markets becoming more demanding, demanding wider credit spreads or more restrictive financing terms? And third, and perhaps the most important, are AI revenue and productivity benefits starting to come in and close that financing gap. And that last point matters a lot because if we look back at the history of periods of rapid technological innovation, ultimately it produced the best returns for companies that were able to harness that technology and improve productivity, improve revenue growth, not necessarily who financed the infrastructure build-out. So debt issuance itself isn’t a red flag. The equity issuance isn’t a red flag, but debt rising faster than the economic return on assets and the cost of that debt is the red flag.

ALEXANDRA: Thank you so much for all that insight, Chris.

Let’s wrap up this portion of the session with Cooper Howard to talk about fixed income before we get to your questions. And we also encourage you to submit more questions to us.

Cooper, bond investors can finally earn meaningful income, but higher yields also come with greater volatility. Where do you see opportunities right now to capture yield without taking on any unnecessary risk?

COOPER HOWARD: Yeah, of course. Well, thanks for having me on this morning, Alex. Broadly speaking, we see a lot of opportunities across the fixed income spectrum. Just to kind of highlight where we are right now, if you look at the US Aggregate Bond Index, which is kind of a common proxy for the total investment-grade… or the investment-grade market, it’s yielding about 5.2%. That’s near the highest that it’s been over the past couple of decades. So we think that that’s favorable both for investors who are focused on that income generation, but also total return over a longer period of time because the number one driver of total return in a fixed income portfolio, Alex, is that coupon income that you receive. So now that that’s a little bit higher, it does provide a little bit of a buffer if we do see rates move up. Obviously, they’re off their peaks that we’ve seen recently, but if we do see them move up from here.

Now, within the fixed income market, Alex, we’re more favorable on investment-grade corporate bonds, as well as high-yield corporate bonds, and then preferred securities, and then also municipal bonds. If we focus on the investment-grade corporate market and the high-yield corporate market, there’s some similar themes there. We’re a little bit more favorable on those because of the absolute yields that they offer. Also, if you look at corporate fundamentals, they tend to be relatively favorable. We’ve been in a fairly strong economy over the last few years, so that’s boded well for corporate profits, and helped them provide a little bit of a financial cushion. I’d be remiss if I didn’t mention tight spreads. We do think that that is a potential risk. But if you look at the high-yield corporate market, a lot of the rise in spreads is really being driven by the lowest-rated rung, those triple-C rated issuers. So what we’re suggesting to many of our investors, Alex, is to focus on those higher-rated portions of the market, whether it’s in the investment-grade portion, or if you’re looking at the high-yield portion, focus on those single-B- or double-B rated-issuers.

Now, within the muni market, again, we do think that this is an area that we’re a little bit more favorable. And again, it comes down to the absolute yields that municipal bonds offer. If you were to just look at the common proxy for the muni market and adjust it for taxes, that’s yielding north of, say, 7% for an investor who is in a top tax bracket. So again, relative to many other fixed income investments, we do think that that’s a fairly attractive yield, combined with our view that credit fundamentals for most municipal issuers tend to be fairly favorable right now.

ALEXANDRA: With yields still attractive, a lot of investors are wondering whether now is the time to lock in longer-term yield or whether it still makes sense to stay in shorter term bonds. Do investors risk missing that opportunity if they’re waiting for clarity from the Fed? And what would tell you that it’s time to start moving further out on the maturity spectrum?

COOPER: Yeah, so yes and no. We do think that right now we’re favoring a slightly shorter than benchmark duration. So again, if you’re using the Ag as kind of your general benchmark, that has a duration of about six years. So I do think in this environment, Alex, a duration of about four to five years can be appropriate. And again, that’s an average. So going back to how I phrased it, yes and no, we do think that it doesn’t make sense to necessarily target one specific part of the yield curve, but instead, spread that duration risk around. That helps avoid the potential risks of locking in yields that are too short, but also moving too far off the yield curve, and being faced with the potential that interest rates do rise and you experience negative price returns.

Now, one of the other things that I think is a tactical idea right now that could be an area of opportunity is to do some tax loss harvesting. We’re moving into the end of the year. And if you look at the return, year-to-date return on the US Aggregate Bond Index, it’s down about a half of a percent. So obviously tax loss harvesting is going to depend on the client’s individual financial situation, their risk tolerance, their asset allocation, asset location, a number of different factors. So broadly speaking, though, it does present an area of opportunity since we do have negative total returns right now or negative year-to-date returns for the Ag, that you can potentially take some of those losses, assuming that your client has those losses and that’s appropriate for them, and then invest in something that’s not a like or similar security to potentially avoid the wash sale rule, and have a investment that still has the same risk tolerance and risk characteristics as that original investment, but you can lock in that potential loss if you have gains elsewhere in the portfolio that you’re offsetting.

So we do think that that’s another tactical solution to look for, but right now in terms of positioning on the yield curve, Alex, we’re suggesting a slightly shorter than benchmark duration.

ALEXANDRA: And Cooper, we discussed this with Chris, but I’m going to pose this question to you from a fixed income standpoint. The AI spending boom is of course increasingly making its way to the corporate bond market. Some of the biggest tech companies are issuing debt to help finance the AI build-out. Is this one of the more interesting opportunities in corporate bonds right now, or are investors not being paid enough for the risk that all of this AI investment takes longer than people expect to play out?

COOPER: Yeah. So in terms of are they being paid enough, one way that we like to measure that is to look at corporate credit spreads. And if we look at corporate credit spreads for kind of the broader hyperscaler issuers relative to the rest of the corporate market, the investment-grade corporate market, they are a little bit elevated there. So it does suggest that investors are being more compensated for taking on the potential AI risk than they are the rest of the investment-grade corporate market.

I also think that if we look at the other story related to the hyperscaler issuers, it has been somewhat of a contributor to the rise in longer-term yields, but we don’t think that it’s overall been the biggest contributor to the rise in yields. If you look at kind of where they’re issuing along the yield curve, about a third of the total amount of issuance is on the longer portion of the yield curve. That’s a little bit unique for corporate bonds who tend to issue on the shorter end of the yield curve.

I also think if we break down the fundamentals of the moves in yields recently, a lot of the move in yields, Alex, has been due to Fed expectations. So we think that if there’s a little bit of a pullback in Fed expectations of the number of hikes that we would expect going forward, that could bring yields a little bit lower, or at least put a little bit of a cap on how much higher that yields can go.

But I think if you look at the overall fundamentals of many hyperscaler issuers, right now we do think that since they do offer a little bit of higher potential yields there, then within moderation they can be appropriate.

ALEXANDRA: Thank you so much, Cooper.

We’ll now turn to live questions from the audience. There are a lot of fantastic ones, so thank you all so much for submitting them.

I’m going to start with Mike on Social Security since it’s such an important topic. You mentioned earlier that Congress is struggling to address big issues. One of the big issues of course is Social Security. What are the chances that Congress finds a solution here?

MIKE: Yeah, Alex, this is a tough one. It’s gotten a lot of attention here in Washington over the last few months because in the spring when the trustees of the Social Security Trust Fund put out their report on the financial health of the program, they said that if Congress does nothing, then the program will be unable to pay out full benefits starting in Q4 of 2032, which is the earliest date that has ever been projected. Now, it won’t be zero benefits. It will be 77-, 78% of benefits, but obviously that’s the point at which things tip over. The reason that got so much attention is that the senators we elect today, it’ll be in their term. So all of a sudden this issue that has been way out in the distance is kind of here. I think this is not going to get solved here in this Congress, but I think a lot of the groundwork is going to be laid. The presidential race that’s going to start probably in a few days here for 2028, this is going to be an important issue in that race because both the Democrat and Republican candidates are going to have to articulate a plan for how they’re going to address Social Security. And maybe 2029, just after the presidential election is your sort of window of opportunity for solving it. But I think this is very much on the radar screen now of members of both parties. I think it’s going to be a bigger part of the discussion going forward, though it may take a little longer for a solution to arise.

ALEXANDRA: Thank you, Mike.

And Liz Ann, there’s one here for you. Which stocks are creating the year-to-date return for the S&P 500?

LIZ ANN: Yeah, Alex, I love that question because I think it’s important always to point out that there’s two ways to think about performance in terms of individual members. There’s contribution to a cap-weighted index return like the S&P, and then there’s simple price performance. So the top three stocks right now in terms of contribution to return are Micron, AMD, and Apple. Now, both Micron and AMD are also in the top 10 in terms of price performance, but here’s an example. Apple is number three in terms of contribution to return, but it’s ranked 141^st in the S&P from a price return perspective. So the difference between price return and contribution is the multiplier of the cap size. Now, Apple is doing okay this year, stronger performance in the S&P 500, but the multiplier of its massive cap size puts it as the number three contributor to returns. The best price performers, the number one best performer in the S&P this year is Moderna. Dell is on that list, Sandisk is on that list. Those are the top three, but they don’t have the cap size, so it doesn’t put them at the top of the list from a contribution standpoint.

ALEXANDRA: Thank you so much, Liz Ann.

And Cooper, we’ll go to you. Until last week, the two-year treasury had a higher coupon rate than the 10-year, even though their yields weren’t inverted. How unusual is it for the two-year to carry a higher coupon than the 10-year, and has it happened historically? If so, did it precede any notable economic or financial market events?

COOPER: Yeah, so I think that this is an interesting one because when it comes down to the yields that fixed income offers, it’s really just a math game. And the yield is ultimately a function of the price paid, as well as the coupon that you receive. And it also brings up a very interesting point. So that we don’t necessarily like to just focus on what is the price versus the coupon received. Ultimately, it’s going to be the yield that is the most important factor. Where we see a lot of this play into investor behavior and biases is in the municipal bond market, and it tends to be that a lot of munis are issued above par because they offer those higher coupons. So what we find from some of our retail investors is that they will try to find a muni that is issued at par, but in fact, what they’re doing is that they’re restricting themselves from a large swath of the overall investment market. So I wouldn’t necessarily focus on it that way.

But also to the other point of the question of does it preclude any sort of major economic event, this really comes up to where we see an inverted yield curve between the two- and the 10-year spread. And historically speaking, that’s precluded every recession that we’ve experienced, except most recently we did experience an inverted yield curve, and obviously we haven’t experienced a recession since that inverted yield curve has come. So I don’t necessarily think that it’s a good indicator of is a recession coming or is it not, because ultimately it depends on the depth of the inverted yield curve, as well as the time to the recession. So there’s a number of different factors that come into play, and also market performance around recessions really varies. So I wouldn’t necessarily use it as a trading indicator or a sign to allocate money one way or another.

ALEXANDRA: And Chris, we’ll go to you next. There’s a great one here from an advisor who says that he asked you back in August if investor capitulation was necessary before finding a meaningful bottom. Your response at the time was historically yes. Do you feel like we’ve seen any capitulation considering what happened in markets over the past week, or do you think that things could get a little bit worse from here?

CHRIS: Thanks Alex. And thanks for the question. I think there’s a number of ways to consider the idea of investor capitulation. One is by looking at market breadth. Market breadth is, and now we look at those measures, we’ve seen an improvement from the weak levels that we saw at the end of September, when about 60% of the market was trading below the respective 200-day moving averages. Currently, that’s rebounded to just 33% trading below their 200-day moving averages. And that’s actually a little bit above the long-term average for this measure. So that’s not showing any signs of capitulation. I believe it was starting to at the end of September, but that’s largely recovered because we’ve seen a broadening out of the rally and improvement from the non-tech stocks.

Another measure is to just look at the magnitude of the drawdown experienced by the aggregate market. A useful rule of thumb is that a 10% correction happens every one and a half to two years or so, while a 20% bear market happens only roughly once every five to six years. Currently, the S&P 500 is just 3% from an all-time high. And if we look at the S&P 500 Equal Weight Index to reduce some of those concentration issues that we talked about earlier, we saw a 6% drawdown into the end of September, but it’s rallied since, and we’re now just 1% from its previous all-time high. So in those two measures, both market breadth and simply aggregate market performance, I’d say we’re not seeing any signs of capitulation. But what we saw in breadth towards the end of September was starting to look quite interesting.

Another area to consider is just various measures of risk appetite. And there we do see a bit more weakness than the other two measures. For example, Goldman Sachs has a widely followed risk appetite indicator, that’s at negative 0.5 standard deviation. So it’s in negative territory, but it’s far from an extreme. And that index typically gets to minus one or worse when we’ve seen larger periods of market stress and some signs of investor capitulation.

So I’d say things got worse from August through September, but now things have improved a bit since then.

ALEXANDRA: And there’s a great question here on data centers. We’ll have Mike and maybe Chris, if you can, respond to it in two parts. The first part is for Mike. Given the likely change of leadership in Washington following election results, is there a concern for a slowdown in data center construction? And then the second part of that, Chris, if you could please talk about how that potential slowdown might affect underlying revenue growth, margin expansion for the hyperscalers. Let’s start with you, Mike.

MIKE: Yeah, thanks, Alex. I think this is one of the most fascinating issues that I’m going to be watching over the next 24 hours. I think as everybody knows, there’s been a huge public backlash about data centers related to the potential for increasing people’s water bills and electricity bills, their strain on the grid, the environmental impact, that sort of thing. And so this is very much an issue in races across the country, from congressional races all the way down to local races like mayor and county races. But I think the states to really watch are Ohio, Pennsylvania, also Texas. Texas has the largest number of data centers in the queue to be built. And we have a potential for some blueness to Texas, possibly. We’ll see. A very competitive governor’s race, and a very competitive Senate race there. So definitely something that I’m going to be watching that I think has the potential for a real slowdown in some of these states as they take a harder look at these data centers and their impact on their voters, frankly.

ALEXANDRA: And then Chris, how much of a risk is that for the mega-cap companies that have been spending so much on data center build-outs?

CHRIS: Yeah, it certainly is a risk. And as Mike said, it’s been something that’s been widely followed and… you know, the backlash against the data center build-out. I think Democratic sweep would probably raise the regulatory risk premium around the AI trade, but it’s not an AI build-out stops-type scenario. The more likely effect is higher costs and slower approvals for marginal data center projects, combined with some tougher AI governance. And I’d also note that the data center backlash is, and Mike mentioned this too, is been a bipartisan one. So some tightening may occur regardless of who controls Congress. And I think that the takeaway for us, and we’re actually working on some analysis now on thinking about different scenarios for the AI innovation way broadly, is that our base case seems to be around a delayed payoff scenario, where the early adopters generate a little bit of value, but the broader adoption lags. There are bottlenecks in the data centers, there are bottlenecks in power availability, electricity availability. So there are already some bottlenecks that have built up before we’ve even seen any additional regulatory issues, whether it’s on general governance or on the data centers in particular.

ALEXANDRA: And Liz Ann, last one for you. One advisor asked you to explain more about what you meant by the mismatch with AI. You said something about technologies leapfrogging. If you could please elaborate on that point that you made.

LIZ ANN: Sure. So let me elaborate on one particular component of the answer that I think will highlight what I meant by that. So there’s a lot more financing being done of the AI build-out as we’ve all talked about in various forms over the course of this era. So leverage essentially is you’re financing the timeline between when an investment is made and when that investment reaps rewards. That’s the whole nature of financing. When you’re talking about the AI-related stocks, the tech stocks, communication services, that whole category tends to be longer duration investments using that fixed income term and applying it to equities. The disconnect is that you’re now moving into a leveraged model, which finances a long timeline associated with getting that money back, yet the change that’s happening in AI is unbelievably rapid. So that’s a little bit of the disconnect. Now, it’s already coming to fruition in things like profitable versus nonprofitable stocks, especially as you go down the capitalization spectrum. So right now on a year-to-date basis, the nonprofitable Russell 2000 stocks are about flat. The profitable Russell 2000 stocks are up about 20%, handily beating even the S&P 500. So that profitability, actually having cash flows and profits now, as opposed to the long duration, you know, we’re paying now for cash flows or earnings well into the future in an environment where the winners and the losers can change really, really quickly in such a rapidly advancing technology that is AI.

ALEXANDRA: Thank you so much, Liz Ann.

And we obviously covered a lot today. So before we finish this portion of the session, I just wanted to go across each of you, and ask what is one thing that is your biggest takeaway from this conversation today? One thing that you want to leave advisors with to go back to their clients. Let’s start with Mike, since it’s election day.

MIKE: Sounds good. Thanks, Alex. Yeah, big, big day, big night ahead. My big takeaway is a really important message for all advisors, and that is to remember that elections are emotional for investors, and whatever happens overnight, whatever happens tomorrow and over the next few days, your clients are going to have an emotional reaction. Some are going to be really, really happy, and some are going to be really, really unhappy. And it’s incumbent upon all of us to have those conversations post-election with our clients to make sure that they’re not making sort of knee-jerk investing decisions based on the election outcome and based on how they’re feeling about it. So be prepared for the rest of this week to have those conversations with your clients, and make sure that they’re making good, sound decisions that aren’t driven by emotion.

ALEXANDRA: That’s a great one, Mike.

And how about you, Liz Ann?

LIZ ANN: Yeah. So certainly every advisor listening to this and watching this and those that were at IMPACT last week know that we always talk about the traditional disciplines, disciplines of periodic rebalancing and diversification across and within asset classes. And those are particularly important when you get internal volatility like we’re seeing right now. But here’s a message about diversification, particularly across asset classes in an environment like this. We often think that as long as you’ve got exposure to equities and then fixed income, and increasingly these days, maybe exposure also in the private markets, private credit, private equity, the commodity space, the real estate space, whatever it is. But let’s be mindful of attribution diversification because you could have a portfolio that has a heavy AI bent within the equity piece. And then you look at the fixed income piece. If there’s credit exposure, that might have an AI bent to it. You go into private credit, private equity, that may have a strong AI bent to it. So make sure we think about diversification at the attribution level, not just the asset class level.

ALEXANDRA: Thanks, Liz Ann. And how about you, Chris?

CHRIS: I think there’s… you know, largely would echo a lot of Liz Ann’s points. I would also say just generally as we’re looking forward to stay flexible, because typically we’ve seen looking at periods of historical episodes of rapid technological innovation that there’s not a static market leadership dynamic. And we see that shift from the early infrastructure plays to some of the early adopters. And then as we get down the line, we start to see who the big beneficiaries are in terms of monetization of the respective technology, in this case, AI. So I think that’s a transition that we’re going to be watching for closely as we go into next year.

ALEXANDRA: And finally, Cooper, how about you?

COOPER: Yeah. So I would highlight some of what Liz Ann said, but I would sum it up in the fixed income market to say, take the risks that you’re being compensated for. And right now, if we look at the absolute level of yields, as well as the shape of the yield curve, really investors don’t need to take on too much duration risk or too much credit risk to get fairly attractive yields, whether that’s looking at investment-grade corporate bonds, municipal bonds, or kind of looking at the US Aggregate Bond Index. Right now, we’re in an environment where investors can receive those yields that have been near the highest that they’ve been over the past 20 years. So you don’t need to dip into long duration bonds, lower-rated issuers, to get those attractive yields. Now, for some investors, that’s going to be appropriate to boost that income up a little bit, assuming that they have the risk tolerance, but broadly speaking, it doesn’t make sense to really take on too much duration risk or too much credit risk in this environment in our view.

ALEXANDRA: Thank you so much. I know that we could all be continuing this discussion for another couple of hours, but regrettably, we are out of time for today. Thank you for joining today’s webcast with Liz Ann, Cooper, Chris, and Mike. Thanks to them for their time and expertise. And thank you to all of you for your time and all of your thoughtful questions. We hope that their insights were helpful to you and your clients, and we’ll send a follow-up email with the replay link.

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