MARK RIEPE:  Welcome, everyone, to Schwab Market Talk. Thanks for your time. The date is September 12^th, 2023. The information provided here is for general information purposes only, and all expressions of opinion are subject to change without notice in reaction to shifting market conditions. My name is Mark Riepe, and I head up the Schwab Center for Financial Research, and I’ll be your moderator today.

For those who are new to these webcasts, we do them once a month. And we’re going to start out spending the first 30 minutes or so asking some of the… answering some of the more popular questions that we receive, and we’ll spend the latter half of the webcast answering your live questions. If you want to ask a question, just type it into the Q&A box and click Submit, and you can do that at any point during the webcast. As for continuing education credits, live attendance at today’s webcast is eligible for one hour of CFP and/or SMA continuing education credit. If you watch the replay, you aren’t eligible for credit. To get CFP credit, please make sure to enter your CFP ID number in the box on your screen. Hopefully, that will be popping up right now. If you don’t see it, don’t worry. You should see it again towards the end of the webcast. To qualify for credit, though, you must watch a minimum of 50 minutes. Schwab will submit the credit to the CFP Board on your behalf. And for CIMA credit, though, you’ve got to submit that on your own. Directions for submitting that can be found in the CIMA widget at the bottom of your screen.

Our speakers today are Mike Townsend. He’s the Managing Director here at Schwab in our Office of Legislative and Regulatory Affairs; Liz Ann Sonders is our Chief Investment Strategist; and Kathy Jones is our Chief Fixed Income Strategist.

And we’re going to start out with a few questions about the economy. Liz Ann, why don’t we start with you. You’ve used the phrase kind of ‘cracks in the labor market’ to describe what on the surface appears to be a source of strength for the economy. What’s your latest thinking on that?

LIZ ANN SONDERS:  Sure. So thanks, Mark. And hi everybody.

Clearly, the labor market has been a source of strength and more resilient than a lot of folks thought, particularly the Fed. And I think that’s tied to the unique nature of this cycle. The fact that services has been more resilient, had a later resurgence relative to goods and services as larger employer, the labor hoarding has been sort of a thesis around this environment. And I think that, you know, has some legitimacy to it.

But the cracks are becoming a bit more notable. Payrolls, which is one of the most widely watched metrics, it is officially considered a coincident indicator, but it’s also highly subject to revision, and in that case, one could argue that it lags a bit. But every month this year, we have seen downward revisions to the data. In fact, if you look at sort of third final revision versus the initial payroll release this year, you’ve seen a revision out of, I think it’s 365,000 jobs, and that’s exclusive of the benchmark revision that the Bureau of Labor Statistics does every year in the preliminary revision where they go back to March of this year, and they revise the level of employment at that time. And, again, separate from these monthly revisions, the level of employment was revised down by more than 300. So, clearly, a decelerating trend.

We’ve also seen, in general, more weakness in household employment. The Household Survey is the survey from which the unemployment rate is calculated. And within that you get things like multiple job holders, the differential between temporary work and permanent work. Those all suggest a slowing down. You’ve seen a compression in hours worked, which I think, especially in this unique environment, that’s an important metric to watch. If there’s legitimacy around labor hoarding, you would pick up faltering demand via a metric like hours work. Wages have eased a little bit, but I think that there are still big macro pressures on wages that we’re living on a day-to-day basis in terms of maybe the power that labor is trying to rest again. So I’m not sure we continue to see that same kind of deceleration there.

And then, lastly, unemployment claims. That’s maybe been the biggest surprise because that’s a leading indicator, and that is not yet showing the kind of significant deterioration. So we’ve certainly seen an easing in hiring. Job openings are down quite a bit, the quits rate is down, but it’s not yet manifested itself in a significant move up in unemployment claims. That would be the sort of next thing to look for if these cracks continue to widen.

MARK:  Well, Liz Ann, let’s zoom out a little bit from the labor market and look at the broader economy. It’s a little bit simplistic just to kind of stick labels on something as complex as the US economy, but if you had to, how would you describe where we are right now?

LIZ ANN:  Well, Mark, as you know, we’ve been using the term ‘rolling recession’ to describe… ‘rolling recessions’ to describe this unique cycle where you had early strength during the stimulus era of the pandemic concentrated in goods and housing, and then those ultimately went into their own recessions. But we’ve had the more recent offsetting strength in services, which we touched on when talking about the labor market. So I think we can think in addition to rolling recession, we can think of these bifurcations that have happened in the economy, the goods versus services, and the different timing associated with those.

You can also look at comparisons like GDP versus GDI, gross domestic income. That’s a much wider spread than is typically the case. And a lot of folks now focusing on which one is telling the more accurate story. And what’s interesting is GDP has been flatter, for lack of a better word, because of inventories, and it looks like the inventory cycle is starting to roll over and move towards something resembling a norm. If that continues, that would suggest that the weaker GDI data is telling the more accurate story for the economy than the GDP data.

But this is sort of an apple in terms of the economy compared to histories, oranges, because there are so many unique characteristics that really require, I think, you know, fine tooth combing all of the data points. I also think nominal versus real is an important differential that needs to be taken into consideration when looking at the data.

I still think a formally declared recession is more likely than not, but the NBER is always very late in making that declaration. I don’t want to say it will be academic at that point, but I think we’ve seen the market price in some of what we have been seeing, which is the rolling nature of how weakness and strength has worked its way through the economy.

MARK:  Thanks, Liz Ann. Kathy, let’s bring you into the conversation. Obviously, the Fed is a keen watcher of what’s going on. The markets… or the consensus seems to be that the market… or excuse me, that the Fed is going to be pausing at their upcoming meeting. Do you believe that? And maybe a follow up there, what do you think would cause the Fed to actually raise rates again?

KATHY JONES:  Sure. Yeah, I think that it’s quite likely that the Fed pauses at next week’s meeting. They’ve signaled that pretty clearly. Even the more hawkish members seem to be saying that they’re okay with waiting to see now that they’ve raised rates to, quote/unquote, restrictive levels. And, you know, as Liz Ann mentioned, there’s plenty of reasons for that. The economy is slowing, particularly the labor market is starting to show signs of cooling off, inflation is falling. So it would make sense I think in their minds to say, ‘Okay, we’ve done a whole lot here. Let’s pause a minute and see what happens.’ But they have left the door open, too, for the rate hikes if inflation starts to accelerate.

I think the motivation behind for the rate hikes would be a rebound in inflation driven by demand factors rather than supply factors. In other words, we’ll get CPI tomorrow… or this week, we’ll get CPI and that may bounce up because of oil prices, but that’s not because excess demand is driving it, but obviously supply adjustments are driving that. So they’re going to look through factors like that.

But if underlying core inflation were to push higher or inflation expectations were to push higher, I think that the Fed would have an argument for hiking rates again, or some sort of, you know, re-acceleration in the economy. It seems very unlikely with financial conditions tightening the way they are, but if that is to be the case, then the Fed would probably feel compelled to move again.

MARK:  Kathy, looking out to 2024, the market seems to be expecting rate cuts next year, so what’s your take on that?

KATHY:  Yeah, I do think that that’s a logical assumption. Now, the market keeps pushing those cuts out, you know, pricing them further into the future because the message we’re getting from the Fed is higher for longer. But timing is always a question mark. We do think probably the Fed is done hiking rates at this stage of the game. We don’t really anticipate a strong likelihood of another hike. And then as we get into next year, presumably the fall in inflation and the slowdown in employment will continue to be the driving force there. But, obviously, a lot is going to depend on the labor market. I think that the Fed will start focusing on that.

But, again, I keep in mind that even if they switch from restrictive to neutral and start cutting rates, the longer they hold, the tighter they get. So as inflation is falling, if they hold rates where they are, then you start to see rising real interest rates, which is tightening credit availability and raising hurdle rates for investment for businesses and for consumer purchases. And then they’re still doing QT in the background. So all that pause is still in the background of tightening. So that could mean that as that continues early next year, we might see a recut if we start to see particularly the labor markets soften.

MARK:  Kathy, as rates have risen, the dollar has risen as well. Do you still see that occurring even if the Fed pauses for quite a while?

KATHY:  Yeah, you know, the dollar had this huge run up into 2022, hit an 11-year high, then it’s a to pull back as expectations shifted about the path of growth in the US economy versus Europe, and then the emergence of China from lockdown. And that was kind of the motivating factor for the dollar to pull back. And now it’s rebounded again because Europe is not doing as well as expected, particularly Germany, and you’re seeing, obviously, China struggle with a number of issues. So the dollar has gotten a boost again, because those interest rate differentials are wide.

Right now, if you look at the US Ag, the yield is about 200 basis points above the Global Ag ex-US. So you still have a negative carry, in general, going into a foreign currency over typically a US dollar-based investor. So there’s a headwind there for the dollar to go down significantly. The exception is probably Japan, where the Bank of Japan is indicating it wants to exit zero interest rate policy. If they pursue that, then that means because their net creditor, you know, money stays home rather than flows out, and that could support the Japanese yen from here. But writ large, I think the dollar bounces up, has more upside than downside from here.

MARK:  Thank you, Kathy. Liz Ann, let’s bring you in and pivot back to stocks. So stocks have been weak recently. Rising interest rates are probably a part of that, a strong dollar maybe factoring into that. We’ve got rising oil prices. Is that all there is or are there other forces at play?

LIZ ANN:  Well, it’s always more than any, you know, one or two things, but I think it is that trifecta, and maybe the unique nature of oil and the dollar both going up simultaneously. Normally, those move inversely to one another, and it just shows that the force is driving oil more on the supply side, and I think the forces driving the dollar in terms of interest rate differentials have been, you know, powerful enough that you’re not seeing that normal inverse relationship. And that has changed the perspective of next year in terms of the Fed reaction function, as Kathy talked about. And when you look at the relatively weak earnings profile, second quarter earnings were down about 3%. The expectation is for a little bit of an uptick. But when you’re talking about, you know, a 20 multiple on forward earnings in an environment where you’ve got the 10-year yield moving up, that, all else equal, puts downward pressure on the more highly valued segments of the market. You had the concentration risk problem. That certainly hasn’t gone away, but I think that that was a factor that started to get more attention, particularly as we went to the end of July and we moved into that August period concern about seasonals, which tend to kick in that August-September time period, sentiment that had gotten a bit frothy. So I think it was a pretty hearty mix.

We haven’t seen a significant pullback, and I think that would probably need some sort of catalyst, but I think we’re at the point, also, in the cycle where we’re no longer in a bad news is good news in terms of market reaction. And I think that’s come into play recently, too.

MARK:  Liz Ann, you mentioned earnings and 20 times forward earnings. What are your thoughts on those earnings estimates? Do you think those are two bullish, too bearish, or about right?

LIZ ANN:  Well, the short and honest answer is I don’t know. I think that the out estimates fourth quarter into next year are, I want to say not realistic. And I don’t mean not realistic, that they’re definitely too high and they have to come down. What I mean by not realistic is we’re in a very unique cycle here in terms of companies’ provision of guidance for analysists to come up with their earnings estimates. It’s not quite as bad as it was a couple of years ago when you had a record percentage of companies that didn’t just guide down. They withdrew guidance altogether. And, Mark, frankly, I think a lot of companies, because some have effectively admitted it, they’re taking advantage of this unique period of uncertainty coming off an era when so many companies just withdrew guidance altogether, and they’re using it as a reason to say they’re still ongoing uncertainty at the macro and micro level, but we’re not going back to the era of precise guidance.

And I think the impact that that has had is analysts are a little nearer-term in terms of making adjustments to the out-estimates. What you’re seeing is more movement in the next quarter when you’re in the midst of earning season, and analysts are getting commentary from companies, they’ll make that adjustment maybe to the following quarter, but not adjusting estimates all that much in the out quarter.

So to say they’re not as realistic as maybe they’ve been in the past, doesn’t necessarily mean they’re too high. For what it’s worth, the two metrics that track earnings most closely are the 10-year yield, which we already touched on. If that continues to break out on the upside, all else equal, that is negative for corporate earnings, and also PMIs, particularly the ISM Manufacturing Index. In the latest reading there, we saw a little bit of an uptick. Still in the sub-50 zone, but if we start to see a reacceleration there and it comes in conjunction with maybe a retreat or at least a stabilization in yields, that’s a bit more supportive of what are seemingly lofty expectations. So third quarter expectation is for a little bit of positive growth, but then you’re into double-digit growth expectation for Q4 and the first three quarters of next year.

I think the ISM Manufacturing and yields would be the two factors I would keep a close eye on, aside from just hearing from companies to judge whether or how realistic those out estimates are.

MARK:  Thanks, Liz Ann. We’ve been sector-neutral for quite some time, and I’ve encouraged people to, at least on the equity side, to emphasize quality as an investment factor. What’s your latest thinking on that?

LIZ ANN:  Yeah, so quality is sort of an envelope that contains multiple factors. So as many know, moving to sector-neutral had to do with our perspective on the macro environment, had a lot to do with the fact that the Fed was moving up off the zero bound, and ultimately initiated the most aggressive tightening cycle in 40 years. So return of the risk-free rate, I think a greater amount of price discovery and reconnection of fundamentals to prices, and we felt that that was a unique environment that favored factor-type analysis and selection versus just the broader overweight or outperform/underperform at the sector level, and really honing in on characteristics and screening associated with that that could be applied across the spectrum of sectors without that pigeonholing. And the types of factors that we’ve been emphasizing that kind of have that quality wrapper around them really span both into value-oriented factors and growth-oriented factors. So unique in this environment of rising interest rates is the necessity of interest coverage. So that’s been a pretty consistent outperformer at the factor level. Tied into that would be strength of balance sheet with high cash/low debt. But also bringing in those growth factors. In a more earnings constrained environment, looking for stocks that have positive earnings revisions, positive earnings surprise. So, collectively, they represent quality, but it’s a collection of individual factors.

And we will talk about sectors and have, you know, outperform and underperform at some point. We just think we’re still in this environment where more of a factor focus makes sense. And there’s been more consistency in terms of leadership and laggard ship at the factor level than there has been at the sector level.

MARK:  Thanks, Liz Ann. Mike, I wanted to go to you. We’ve got the possibility of a government shutdown on the horizon. So two-part question here. First, do you think that’s going to happen, will we actually have a shutdown? And, secondly, you know, historically the markets have kind shrugged those things off. Do you think that’s going to be the case, as well, this time?

MIKE TOWNSEND:  Yeah, Mark. Hi, everybody. You know, I do think that the risk of a government shutdown this fall is quite high, but the timing of when that might happen still is kind up in the air, and I’ll explain the kind two different scenarios. But just to remind everyone how this is supposed to work, each chamber is responsible for passing the 12 appropriations bills every year that fund every government agency and every government program. It’s supposed to do that by the end of September, and that’s because the government’s fiscal year of course starts on October 1^st. And if they’ve not passed the 12 bills by then, they can either pass a short-term extension to buy themselves some more time, which is usually what happens, or else they have a government shutdown. As of today, the House has passed exactly one of those 12 bills. The Senate has passed zero. Both chambers are sort of working their way through those bills and will continue to do so, but there is basically no chance that that’s going to be finished by the end of this month.

So the plan for Congress is to pass what’s known as a continuing resolution. That’s this temporary measure, short-term extension, maybe until, say, mid-November, or something like that. This is very common. Congress does this all the time. And if they do that, then they have, you know, a bunch more weeks to negotiate a longer-term deal.

But here’s the first risk of a shutdown. The White House has asked Congress to include about $40 billion in emergency spending on that short-term deal, about 24 billion for Ukraine, the rest for US disasters, like the Hawaii wildfire and the recent hurricane in Florida. But it’s Ukraine that could be problematic because there’s some growing opposition to continuing to fund the war in Ukraine. And there’s a lot of House conservatives, in particular, who feel like we’re spending too much, it’s adding to the deficit, and that it runs contrary to their larger goal of reducing overall government spending. So they’ve actually threatened to block that bill to keep the government open if it includes Ukraine money. So I think that’s the first sort of inflection point and will be the big focus over the next couple of weeks.

If that gets resolved, then I think shutdown moves to November-December timeframe. And that’s because the two chambers are starting in totally different positions in terms of how much funding they are allocating. Based on the debt ceiling deal back in June, President Biden and House Speaker Kevin McCarthy agreed to keep funding for the coming year at current levels, but House Republicans, frustrated that there wasn’t more cuts in spending, are passing bills and negotiating bills that start at 2022 levels. It’s about $120- to $130 billion less in overall spending than the Senate numbers, and those two things are, obviously, ultimately, are going to just run into each other.

So I think there’s going to be a big battle probably later in the fall, and that’s where the risk of government shutdown is probably highest.

As you said, you know, the bottom line is the markets, historically, have not cared a lot about government shutdowns. In fact, the S&P 500 has gone up during the last five government shutdowns, so you can make of that what you will. But I think time is the important thing. You know, a shutdown of a few days, not a market event. Once you get into a few weeks, you start to have broader economic impacts and potential market impacts there. So that’s what I’ll be watching for.

MARK:  Thanks, Mike. Kathy, let’s go to you. I’ve got a few questions about the bond market. And, Mike, then we’ll come back to you. Kathy, maybe, you know, we had a lot of macro discussions up to this point. Given all that, what’s your kind of overall outlook for the bond market at this point? And then we’ll get into some more details.

KATHY:  Sure. So, you know, broadly speaking, we see… you know, we think we’re near the peak of the cycle. Remember that bond yield are driven by the expected path of short-term interest rates set by the Fed plus or minus this term premium, which compensates you for tying up your money for a period of time. And what you see when you get into the mature part of the cycle is the curve kind of flattens out because you get to where you’ve priced in those rate hikes and the short-term market, you know, levels flow into the intermediate, etc. So that’s kind of where we are.

So the short end of the market stays elevated up to the two- to three-year area in expectation that the Fed is on hold for a period of time. That’s longer than was anticipated. That’s helped levitate those yields. The intermediate part of the curve has come up because (a) it’s also pricing at a higher for longer, but you also have had a more resilient economy than expected and worries about whether inflation will actually continue to fall. And then as you go further out the curve, a lot of concerns have surfaced because of the rising supply of treasuries to be issued as our deficits rise.

Now, having said that, I still think we’re in the upper end of where yields are going in the treasury market simply because, you know, if you believe, as we do, that the economy is going to slow down, inflation is going to fall. That’s the big driver. Supply is not highly correlated with yields. And I know there’s a lot of talk about it and a lot of concern about it, it makes sense, but at the end of the day, I’ve looked at this a billion different ways over many decades and the correlation between the supply of treasuries issued and yields just isn’t high in a short-term, intermediate-term, or long-term basis. So, you know, I guess if we’re going to have a problem with supply, it will be kind of unique to this cycle. But overall the big driver is inflation, and continue to see that steadily coming down.

MARK:  So given that outlook where is the duration sweet spot right now?

KATHY:  Yeah, when you look at the treasury curve… you know, we usually try to tell people to spread out their duration, you know, get some of the average in the middle near benchmark, like the ag around 6, just so you’re not trying to time the market because that’s really hard to do. But if you look from a tactical point of view, that two- to five-year area in the treasury market seems to offer the best risk-reward, and I think that’s probably true in the investment-grade corporate bond area, as well. So if the Fed does pivot next year into easing, this belly of the curve is where you’re going to see the biggest rally because that’s going to adjust to the expectation of lower rates faster than the short end or the long end, and you get a nice fat yield for sitting there. So in the treasury market, you’re, you know, 4-3/4- to 5%. In investment-grade, you’re 5-plus for sitting there. So if I was very tactical about it, I’d be in that two- to five-year area.

MARK:  What about credit? You know, credit spreads, especially high-yield spreads, seem to be tight. Do you think they’re too tight?

KATHY:  You know, we do think they’re a bit too tight. Now, obviously, there’s some reasons for that. One, is just supply-demand, particularly in the high-yield market. We haven’t had that much issuance, as a lot of companies termed-out their debt and we really don’t hit a big maturity wall until next year. Also, the private credit markets have absorbed a lot of the riskier parts of the market. It’s moved into private debt, private credit funds. And so you’re not seeing it, and that’s keeping spreads low.

Our view is, though, that, you know, of the things that we watch, credit is still fairly risky, particularly lower-rated and high-yield credit. So we watch things like, you know, tightening bank lending standards, the inverted yield curve, and deteriorating growth outlook and various indicators. And those are all signaling, you know, warning flags, even those spreads are low.

So I think, you know, just because you move bad credit or junk credit into a world where there’s no mark to market doesn’t mean it still doesn’t exist. Some of these companies are paying upwards to 10% in financing now. So I think we will see a default rate cycle that increases over the next year or two. So we’re cautious on high-yield. Risk-reward here just isn’t that attractive. You can clip the coupon. If you can ride out the volatility, that’s fine, but I wouldn’t have a big allocation to lower-rated credit right here.

MARK:  And I was going to ask you about munis next, but, actually, we just got a question about munis. So where is the sweet spot for munis?

KATHY:  Yeah, unfortunately, sweet spot, the muni market is still kind of pricey. You know, spreads have been tight, the MOB spread has been low for quite some time. We’ve seen just such a rush of money into muni funds, and its short-term munis as rates have moved up. So, you know, a lot of investors pour in there, and that’s really compressed. The MOB spread pushed shields down, particularly at the front end.

So if you wanted to… from a valuation point of view on the muni curve, you know, you’re probably looking out towards a 10-year area where you get a decent spread versus comparable treasury. So it’s not as easy as it might be from kind of a duration point of view as it is in the investment-grade market or in the treasury market. But the further out you go and the lower credit quality you go, the more yields you pick up. We think the sweet spot is probably the A-rated area. You still have very, very low risk of default, fundamentals are still good, and you probably get the best spread in that sort of 10-year A-rated muni world.

MARK:  Thanks, Kathy. Mike, I’ve got a few questions for you. I think Chairman Gary Gensler of the SEC is, literally, testifying right now. What are the key regulatory issues that advisors should be aware of that may be coming down the pike from the SEC?

MIKE:  Well, I might need the rest of this webinar to go over them all, but I’ll highlight a few. It’s a really long list. The SEC has an incredibly aggressive agenda. You know, we have things like the SEC’s equity market structure overhaul proposals. There’s the potential for swing pricing and a hard 4:00 PM close for mutual funds. And there’s some rule proposals for advisors around things like cybersecurity and due diligence of third-party vendors that I think are pretty important. But I want to highlight two, in particular, that I think the advisor community really needs to be thinking about.

One is proposed updates to the Custody Rule, which is what the SEC is now referring to as the Safeguarding Client Assets Proposal. This was proposed earlier this year, but the SEC recently reopened the comment period to get more feedback. The proposal would significantly expand the kinds of assets that fall under the rule and require also a cumbersome written agreement with custodians, among other changes. So if you haven’t had a chance to look at it to really think about how it might impact your business, there is more time now. You have this kind of open window until the end of October to provide additional comments to the SEC.

The second one I wanted to highlight, a relatively recent proposal that deals with conflicts of interest in the use of predictive data analytics. It’s kind of a mouthful, but when you dig into this proposal, it’s really, really concerning. Basically, the rule would govern any interaction with a client in which an advisor uses technology to provide or support providing advice. And instead of simply requiring disclosure of any conflicts, which has been the standard in the industry for decades, it would require advisors to eliminate or neutralize the conflict, which is just a very different thing than just disclosing it. There was actually an op-ed piece in the Wall Street Journal on Monday that I think does a good job of sort of laying out the serious repercussions of this rule, and the degree, frankly, to which the SEC seems to be overreaching here. The comment period on that one is open until October 10^th.  And I encourage advisors to take a look at this proposal because there’s some real serious implications here. It really goes at all sorts of interactions with clients, and I think it would change the client experience if it were to actually go into effect. So that’s one we’re really paying attention to.

MARK:  Thanks, Mike. The IRS recently announced that it’s delaying a key provision of Secure Act 2.0 that was supposed to go into effect in January. So I was wondering if you could kind of explain what that’s all about and why it matters?

MIKE:  Sure. You know, Congress, of course, passed the Secure Act 2.0 late last year, made a bunch of changes to retirement savings. Obviously, the most notable of which is already in effect is raising the RMD age from 72 to 73 that went into effect this year. But, actually, the bulk of the provisions from that new law kick in in 2024. And one that was causing some concern is a new requirement that employees who are aged 50 and over and who earn more than $145,000 will be required to make catch-up contributions to a Roth account. And earlier this year, it became clear that the industry just wasn’t going to be ready for this. Frankly, there are lots of companies that don’t even have a Roth 401(k) option in their plan. And even among those that do, there’s huge system changes that have to happen here. You know, companies need to be able to identify the employee’s age, how much they’re earning, and then direct their regular contributions and their catch-up contributions, ultimately, to different vehicles.

So there was a loose coalition that came together here in Washington of employers and financial services companies and retirement services providers, and sent a letter to the IRS that basically said, ‘We need a delay to work on the systems changes.’ And late last month, the IRS did come through with that delay. They announced that that provision will be delayed for two years until 2026. And it just gives companies more times to get their systems ready for that. But it also, I think, it’s just good news for financial planning and for people saving for retirement to have some clarity on that.

That same IRS notice also clarified something else that had been causing some confusion. Due to a drafting error in Secure Act 2.0, there were a few lines that were inadvertently dropped, and the result was that it appeared that all catchup contributions were going to be prohibited in 2024. And this recent IRS notice clarified that that’s not the case. Catchup contributions are good to go and can proceed as normal in 2024 and beyond.

So these are kind of two elements that were hanging out there that we’re causing a lot of confusion, and we actually got some clarity from the IRS, which is a relatively rare thing.

MARK:  Thanks, Mike. Liz Ann, let’s see, I’ve got a couple questions here for you. The first one, how do you view the GDPNow forecast for Q3 in light of the idea of a slowing economy?

LIZ ANN:  So the one thing I would say is that GDPNow, which comes out by the Atlanta Fed, is actually not a forecast. It’s called a nowcast. So what a nowcast does, it takes the information that has already come in. Ultimately, the factors that go into the GDP equation, they look at the ones that have come in, and it’s sort of a snapshot in time. And given that, at least based on the data, most of which is through August, you’re talking about two-thirds of the quarter’s data is in, and that’s what this nowcast is based on. So it’s not a forecast, it’s just a snapshot. And given the deterioration in many of the drivers of GDP that we have seen throughout the quarter, that is likely to come down as more data comes in.

Now, there’s some differences in how these nowcasts are calculated. The New York Fed had a competing nowcast that they stopped publishing, I don’t remember how long ago. It was quite some time ago. And they just started republishing it. I just saw the notification on that today or yesterday, and need to look in again at the differential in how they put those numbers together, because unlike 5-and-change out of Atlanta Fed, New York Feds is low 2s, I think 2.2%. But, again, it’s important to differentiate between a nowcast and a forecast.

In terms of the blue chip consensus, which when Atlanta GDP publishes their GDPNow, you can just Google it, the chart where they show the nowcast and the changes over time, they also show the blue chip consensus. And the nowcast for this quarter has been way above the band and the average for the blue chip consensus. And that consensus is actually a forecast for the full quarter.

MARK:  Next one, Liz Ann, also for you. Are unemployment claims lower than they would be historically… or maybe what they would’ve been historically, based on the government support and stimulus cash? Possibly not enough incentive to be looking for jobs compared to past contractions.

LIZ ANN:  That may be a part of it. It’s also the case that in the early stage of starting to see some softening in the labor market, when you had a lot of high profile layoff announcements that, frankly, were more top-down in nature… that’s another thing that differentiates the cycle from other cycles, is when the layoff processes started it was more top-down. And what I mean by that, it was up the income spectrum, up the wage spectrum, into the managerial class, even into the C-suite. You certainly saw that in the technology space. You saw it in financial services, which really kicked into a higher gear during the banking crisis… that’s what we’re calling… it back in the March timeframe.

So in many cases, a lot of the folks that were being laid off earlier this year and in the early part of the layoff cycle were not only up income spectrum and may have not had that near-term incentive to quickly file for unemployment insurance, in some cases, they weren’t eligible to do so because of severance pay. Yes, there might have been a stimulus factor at play. There’s also been a lot of sort of vagaries inside the individual numbers at the state level, some misreporting. So there’s a little bit more of a, you know, take it with a grain of salt. I think it is the case that a large percentage, I think it’s more than 75- or 80%, of states are now in rising claims mode, but you’re not seeing the kind of increase you might have expected to see in the past.

And I think it’s also going back to what I said when you asked the early question, Mark, about the labor force, is there is a bit of labor hoarding. So we just might be in a cycle where the span from layoff announcements, job openings coming down, payrolls weakening, and when you start to see the real material increase in unemployment claims, that span may be a bit elongated in this cycle relative to past cycles.

MARK:  Thanks, Liz Ann. Mike, this one is for you. What about IRS guidance on how to calculate the 10-year withdrawal for IRAs?

MIKE:  Yeah, so this goes back to the change in the original Secure Act that said that non-spousal beneficiaries who inherit an IRA have 10 years to distribute the assets in that. And when that came out, it was interpreted by pretty much everybody that said you could do that in whatever way you want. If you wanted to wait nine years and 364 days and take it all out on the last day that that seemed to be okay. IRS came out a year or more ago and said no, you’re supposed to be taking annual distributions. And that created this whole outcry about, ‘Well, you changed the rules in the middle of the game, and I’ve already missed annual distributions’ and that sort of thing. So the IRS said for 2020, 2021 and 2022 that you didn’t have to take distributions. And they’ve just over the summer announced that you don’t have to take distributions if you’re in that situation for 2023. That doesn’t mean that they’re changing the rule, necessarily. So we’re still waiting for that rule to be finalized. But we do know that the IRS is not requiring non-spousal beneficiaries who inherited an IRA to take an annual distribution in 2023. So we’re going to continue to monitor that to see how the final rule comes out, but not necessary in 2023.

MARK:  Thanks, Mike. Kathy, this one is for you. ‘Kathy. I read a lot that China is not buying treasuries any longer, but getting their dollar exposure through commodities. If so… well, first of all, is that true? And if so, what are the implications?’

KATHY:  So I wouldn’t say it’s technically true. China’s reserve holdings of US dollars have come down from a year ago, and that probably, you know, reflects a lot of different things going on in terms of the internal financing needs of the government and their desire to perhaps diversify their holdings. But I don’t think that… this kind of gets to the heart of this. You know, are they going to dump all their treasuries? Are they going to move away from the US dollar? And that’s very difficult to do. First of all, there’s a liquidity issue. If you’re trying to get dollar exposure through commodities, then what are you going to do, like sell a bunch of soybeans in order to raise money? And that’s a little bit of a time-consuming and difficult process, as opposed to selling some treasuries, right, or having that cash available for trade.

So, you know, there’s a lot of different stories going around about who’s holding treasuries and who isn’t holding treasuries. I will only say that globally holding of US treasuries has moved up to a record high among foreign investors. We see oscillations between central banks in terms of their reserve holdings depending on what they’re doing. Japan has drawn down a bit. That’s partly because of what Japan is trying to do to stimulate their economy. So you see these oscillations, but overall it’s not really workable yet. Maybe someday it will be, but it’s not really workable yet for the global economy to function without US dollars.

So as much as there’s a lot of talk about it, you hear about the BRICs trying to get together to have a trading group where they trade in their own currencies, but at the end of the day, they have no common institutions, they have no common financing, they have no plan to have those things, they have no common currency. And there’s certainly a lot of disagreement between some of the major players like India and China and Russia about those things and how that would work. So a lot of talk about it, a lot of plans moving away from the dollar, but at the end of the day, you know, it’s really hard for the global financial system and economy to function without a high level of dollar usage.

MARK:  Thanks, Kathy. Liz Ann, this one is for you. ‘Can Liz Ann expand on her thoughts that good news is no longer bad and bad news is no longer good?’

LIZ ANN:  Well, I think because there’s such an uber focus on near-term Fed policy, the September meeting, the November meeting, what the trajectory looks like next year, you tend when you’re in the early part of a window to a Fed pause, the desire to see that pause come sooner rather than later, sometimes you get a market that cheers bad news because it means maybe the Fed can kind of lift its foot off the economic break. You then typically transition if the economic data continues to worsen, such that recession becomes in clearer sight, regardless of whether the Fed can take their foot off the economic break. That tends to step in, and you go from a short-term window where bad news is good news from the perspective of Fed reaction function to bad news is bad news because the economy is weakening to recession level conditions. Ultimately, that’s not good for the equity market. So it’s not abnormal to see that shift occur, and I think we’re now maybe past that point where consistently the market is going to be cheering worse economic news.

MARK:  Thanks, Liz Ann. I’ve got another one for you. ‘Does Liz Ann expect an impact in October due to student loans again starting to be repaid?’

LIZ ANN:  So I think we’re already starting to see an impact. You’re certainly seeing it in the numbers. Now, there was some thought, I don’t know if you call it concern, but some thought that because there’s no real significant penalty to not paying, that maybe the vast majority of those holding student debt would just say, ‘Nah, you know, I’m going to keep not paying.’ But the reality is that payments have kicked-in to a significant degree. And one way to track that is you look at the Department of Education and the deposits of the DOE in their Fed account, and that’s gone from like, I think, 1-1/2 I think it’s trillion… shame on me for not knowing whether it’s the B or the T… up to closer to 10. So you’ve basically seen a tenfold increase in the amount that is being paid. And this data is looked at on a rolling 30-day basis. So call it the last, you know, few weeks you have seen that significant increase.

Now, whether it immediately impacts consumption metrics like retail sales, which we’ll get this week, we’ll have to see. But, unquestionably, the payments are starting to kick in. And when you think about some of the other pressures on the consumer, it certainly wouldn’t surprise me to see it start to show up in earnest more in those consumption-oriented stats like retail sales.

MARK:  Yeah, I’m going to broaden that question a little bit with another question that came in. ‘Is the increasing debt load and reduced savings for the average consumer a cause for concern?’

LIZ ANN:  Yeah, you know, the consumer is in healthier shape, in general, than they have been in past cycles, and to some degree, took advantage of the low rate environment to shore up balance sheets. That doesn’t apply to every consumer, of course, and inflation tends to bite at the lower end of the spectrum, and that’s also where you’re seeing a significant increase in the use of revolving credit. So I think you do have to start to segment the consumer now at the wage and income level in terms of things like the savings rate, and excess savings thesis, and the application of net worth kind of statistics to consumption patterns. But, in general, consumer balance sheets are healthier, as for the most part, are corporate balance sheets safer, you know, moving down into the low-quality zombie end of the spectrum.

Where I think the real bite is starting to be felt, and as we anticipated heading into 2023, in fact, we put it in our 2023 outlook as one of the not forecasts, but thoughts around what 2023 would be defined by, that government debt and the cost of servicing that debt would become a much larger part of the conversation, so to speak. And I think that is clearly coming into the mix. And that… we know the focus has been on government debt and, you know, when you hit the tipping point, and what if interest rates go up, what’s the impact? It didn’t seem like politicians were forced to have adult conversations about it. Now I think there’s a broader awareness beyond just the investor class of the implications of this, a crowding-out effect. So that’s where I think the real bite is in this cycle, is actually on the government side. Less so in the private sector side, either corporations or consumers.

MARK:  Thanks, Liz Ann. And, Mike, we’ve got a comment here from a listener that I think echoes a little bit what Liz Ann was just talking about. ‘US government interest payments have increased by a huge amount. Please comment.’ Other than… Mike, you were talking about sort of the government shutdown, this is being something of focus on certain aspects of the Republican Party, but, in general, as we see that interest expense going up much higher than it had been over the last five to 10 years, is the political class generally interested in this?

MIKE:  Yeah, I think the political class is, or at least some of the political class is, and you’re certainly seeing this play out, as you said, in the government shutdown, which is really a larger discussion about how much spending there is. But, you know, I go back to the debt ceiling debate that we had in June, where we got, you know, within a couple of days of defaulting. You know, remember that that was not about reducing the debt or the deficit, right, and it’s about raising the amount that we can accumulate. And now that’s off the table until sometime in mid-2025. And I think once that’s off the table, you know, it’s just hard to keep politicians focused on that. So you’re heading into an election year. You know, then that changes the equation too. So I think this is very much on the minds of people, but we’ve seen over decades that it being on the minds of people and actually having them do anything about it is a very different thing.

MARK:  Kathy, I’ve got a couple of questions for you. The first one is pretty short. ‘Kathy, could your plant use some water?’ So I’ll just throw that out there as a public service comment.

KATHY:  I will say I think it’s fine. We have a service that comes in. I’ve been away for a while, but I’m sure the nice lady who takes care of the plants has been here.

MARK:  Alright. Now that we got that out of the way, ‘What is it going to take to get the yield curve to normalize and when may that happen?’

KATHY:  Most likely, in most cycles, the way it normalizes is you start to get the Fed rate cuts. And so the short end comes down… you know, we’re already kind of flattish, we’re still inverted, but relative to how inverted we were a little bit ago that it’s less inverted, and you’re seeing a very flat out to about, you know, three to five years. Normally, what you do in a cycle is the Fed starts to cut and that normalizes the curve. And that’s why, typically, long-term rates peak before the last rate hike because the market anticipates that.

Now, in theory, it could go the other way. I guess if there was enough concern about inflation and inflation expectations spiked up, long-term rates above short-term rates, that could happen, but that seems unlikely and that’s a very unusual kind of scenario. So, more likely, it normalizes as the Fed starts to hint that they’re going to bring down short-term rates.

MARK:  Alright. Thanks, Kathy. Actually, Kathy, I’ll ask you one more question, and then we’ll start to allow each of you to wrap things up. The question for you, Kathy, ‘The Fed has said it will continue quantitative tightening even when the time comes to cut rates. What will that mean for the bond market?’

KATHY:  That is a major question that I don’t think anybody knows the answer to. So what we have is a case where the Fed feels confident, has expressed confidence that they can on the one hand ease policy by lowering rates and on the other hand continue to tighten policy by doing quantitative tightening. Now, the theory is that… you know, the pinch point becomes when they drain… so quantitative tightening drains reserves, easing rates, tends to raise reserves in the banking system. The pinch point comes when, you know, you don’t have enough reserves in the system, and we ran into that back in 2019.

So I think this is a grand experiment that they’re going to set out on. I think they believe that some of their other tools can be used to address this. And they are very eager to get that balance sheet down, particularly their mortgage bond holdings. But I think this is a potential risk. I don’t know that the policymakers and the tools that they have can be calibrated so precisely that we don’t run into some pretty major liquidity issues. So it’s going to be interesting to watch.

MARK:  Alright. Thank you, Kathy. So maybe let’s just go around the horn here, and, Mike, will start with you, a couple of key points you want to leave people with.

MIKE:  Yeah, sure. You know, first, the fight over government shutdown is probably going to last through much of the fall. That’s going to dominate things here in Washington, but probably not a big market mover if and when it happens.

As we head into an election year, the attention on getting policy done is going to go down. Congress is going to have a hard time to get much done, and that means the regulators are going to be very, very busy.

One thing I didn’t mention, Department of Labor is about to come out with yet another attempt to redefine who is a fiduciary in the retirement savings context. I mentioned all these SEC proposals that are going to come to a head. I think that’s where the real energy and focus is going to be in terms of things that affect advisors and the markets over the next six to nine months.

MARK:  Thanks, Mike. Liz Ann, a couple thoughts from you.

LIZ ANN:  Sure. So I think we’re at a potentially interesting transition point here. And this is an attempt to widen the lens and think about the secular environment that we’re probably transitioning into, and how it is similar or maybe very dissimilar to the so-called great moderation era that we essentially exited by virtue of the pandemic. And that’s where we’ve been devoting a lot of our attention, is thinking bigger picture and looking at relationships that may be changing, possibly a more volatile inflation environment akin to the three decades or so that led into the great moderation. That’s not the same thing as saying inflation is going to stay high in perpetuity, but more inflation volatility. And that could be driven by more geopolitical concerns and fractures, as well as things like climate change. I think it manifests itself in what we’re seeing already, which is a move down back into negative territory in terms of the correlation between bond yields and stock prices. For almost the entire period of the mid-‘60s to the mid- to late-‘90s… I’ve been calling out the temperamental era… you had an inverse relationship because yield volatility was driven by these bursts of inflation, and so higher yields was typically negative for the equity market and vice versa. And that was not the case during the great moderation, you know, the global economy being more subjected to supply shocks. And then an interesting thing that may be starting to happen is for much of the great moderation era profits were at a very high share of GDP and labor as measured by wages, very low share of GDP. For the temperamental era, you had the opposite, and we’re starting to see a little bit of a convergence.

So I think it’s important now sometimes for us to step back and think, ‘Okay, does the secular environment look like it’s maybe changing to one that a lot of investors are just not used to?’

MARK:  Thanks, Liz Ann. Kathy, any final thoughts from you?

KATHY:  Sure. I’ll keep it short because we’re at time. I agree with Liz Ann. We’re in for more volatility in interest rates. Partly, that’s just we’ve come from a long period of zero interest rate policy around the world to positive interest rate policy. Uncertainty about the direction of policy, by definition, is going to give you a lot more volatility in bond yields.

That being said, real rates are at the highest level since 2007-2008, pretty much across the treasury curve, and to some extent in the investment-grade corporate bond world as well. And we think it’s an opportune time to add some duration if you haven’t added duration to at least go out towards the benchmark, say, you know, five- to six-year period.

And I guess the third thought is lots and lots of talk about the collapse of the dollar. I think if you want to worry about things, push that one down to the bottom of your list because there’s really not much to support that argument.

MARK:  Thank you, Kathy. And thanks for all our speakers, Mike Townsend, Kathy Jones, and Liz Ann Sonders.

Thanks for your time today. If you would like to revisit the webcast, we’ll be sending a follow-up email with a replay link. To get CE credit, you need to watch at least 50 minutes in order to get it, and you have to have watched it live. No credit if you watch the replay. To get CFP credit, please make sure you enter your CFP ID number in the window that should be popped up on your screen right now. Schwab will submit your credit request to the CFP Board on your behalf. For CIMA credit, you’ve got to submit that on your own. Directions for submitting it can be found in the CIMA widget at the bottom of the screen.

The next installment of this series of calls is going to be October 3^rd at 8:00 AM. Kathy, Mike and Liz Ann, as well as Jeff Kleintop, will be with us on that call. Until then, if you would like to learn more about any Schwab insights, please reach out to your Schwab representative. And thanks for your time today.