2026 Market Outlook: U.S. Economy, Equities & Fixed Income

KATHY JONES: I'm Kathy Jones.

LIZ ANN SONDERS: And I'm Liz Ann Sonders.

KATHY: And this is On Investing, an original podcast from Charles Schwab. Each week we analyze what's happening in the markets and discuss how it might affect your investments.

KATHY: Well, hi, Liz Ann. It's that time of year when we start looking ahead to the new year and trying to make some educated guesses about what the markets might or might not do.

LIZ ANN: That's right. So it's time to get out the crystal ball. I don't know about yours, but mine is always a little bit hazy. Maybe not much different this year than past years. But I wanted to remind everybody that have been regular listeners of our podcast, and thank you for that, that the format of today's show is a little bit different from the typical episode because we are going to focus just on our outlooks for 2026. And as usual, we'll cover the equity side of things, we'll cover the fixed income side of things. But I want to start with the overall economic outlook. And I want to bring in our colleague and head of macro research at Schwab. So Kevin Gordon, thanks for joining me to discuss the outlook for the U.S. economy.

KEVIN: Hey, Liz Ann, and always good to be back. Happy almost 2026.

LIZ ANN: Ditto. So Kevin, let's start. We've always tried to have at least a little bit of fun with our outlooks. That's the nature of how dour our business can sometimes be that you want to bring some light into it. So you know, we've had some fun really over the last several years with incorporating the notion of the K into this unique cycle, kind of K-shaped backdrop. We also throw in some other letters in our outlook, including the U's, which we can maybe start with, and maybe also AI. So I think this outlook is brought to you by the letters U, K, and AI.

So let me just set the stage a little, and then I'm going to ask you to sort of launch into some thoughts on the K. One of the things that we have focused on a bit is maybe shifting a focus away from what is, I think, an overuse of the word "uncertain" to describe the backdrop, as if the backdrop is ever certain. And I think the better maybe "un"-word this time is "unstable" because there's so many forces moving in real time, and they're having impacts at different times on different segments of the economy. And it has meant we have developed pretty clear bifurcations that have kind of defined this K-shape. So why don't we start there, maybe talk in a broad sense, Kevin, about what some of these bifurcations are and what the outlook is for any possible convergence in some of them in 2026.

KEVIN: Yeah, I mean, you know, all the letters, it's really, I've been thinking about it as this alphabet economy, but then I figured we probably can't call it that because that's a specific company that happens to be in the Mag Seven. So then I was like, "Well, we shouldn't call it alphabet." But you know, I think that what's really interesting, I mean, to your point about these, these sort of unstable nature of the economy, it's really hard to see all of the dynamics that are going on if you're just looking at the headline numbers, and you know, if you look at GDP, it's expected to bounce back pretty strongly in the third quarter. We haven't gotten the report yet, but it's delayed because of the shutdown. 

But even into the fourth quarter, yes, that's probably artificially depressed a bit because of the shutdown, probably gets artificially inflated a bit in the first quarter of 2026. But you look at that, you look at unemployment, you know, the unemployment rate at 4.4%. None of that really tells you what all of this churn underneath the surface of the economy is looking like. And I think that the really interesting point about this K-shaped nature of the economy is, you know, I think a lot of people initially thought about it, and certainly we were in the same camp, you know, a few years ago of the upper part of the K just being people that made a lot of money, and then the lower part being people that didn't make a lot of money—or wealthy individuals and asset owners versus less wealthy individuals and asset owners. But what's interesting is it's being populated more by things that don't just have to do with money. So I think about the youth unemployment situation in America, that's sort of an example where there's a lot more stress now at the bottom part of the K, and it's harder for people to be able to find jobs. We know that the rehiring rate is very low, the job-finding rate is very low, we just got the JOLTS survey data for October, and the hiring rate fell back to a cycle low. 

LIZ ANN: And I know our producer knows I'm about to interrupt Kevin here. "Job Opening and Labor Turnover Survey." 

KEVIN: That's right. 

LIZ ANN: JOLTS for short. So back to you, Kevin. 

KEVIN: Exactly. Thank you for defining that. I always forget to do that. Yes, JOLTS, not like the actual jolt of energy, JOLTS in terms of the survey name. But you know, all of that is really still pointing to this really interesting backdrop where you have a lot of this stress under the surface, but it's led largely to kind of the stagnant labor market. And when you think about one of the central themes to our outlook for '26 is for labor to be kind of this mix of a headwind and a tailwind where the headwind is that you probably have some more upward pressure on the unemployment rate. There is a little bit more of a weakening of labor as we head into the end of the year. We know from some of the private-sector data that we get from ADP or from Revelio Labs that payroll growth has continued to slow at a pretty marked pace. But we also have this really interesting downward pressure on labor-force supply growth because of the immigration backdrop in the United States this year.

So it puts labor in this really interesting spot where if you do see a continued slowdown in payroll growth, you could probably see how there's a little bit more of slower-wage backdrop into the first half of next year. And that maybe puts a little bit more of a break on spending. I don't think that it leads to this catastrophic decline in spending, barring some sort of big recession. But at the same time, if you keep the total stock of labor relatively high every single month, which is where we're at right now, we have almost 160 million non-farm payrolls in the U.S. So if that's the case and you that many people, you know, month-to-month that are making money, that are able to pay their bills, you know, relatively speaking, you know, relatively well, and that keeps the economy going, then you don't have a whole lot of disruption to the economy itself.

LIZ ANN: Hey, Kevin, one quick question. So … and I'll get into large companies versus small companies in the context of the market, but I think it's an important point to make about the size bias in terms of where payroll growth is still strong and where it's weakest.

KEVIN: Oh no, yeah, I think that's the that's one of the most important splits in the K-shaped nature of the economy, because, you know, when I talk about the ADP data, for example, they do segment employment when it comes to small and large businesses. So over the past couple of years, and we have this chart that's in our outlook for anyone who hasn't looked at it yet, but if you look at employment growth over the past couple of years for companies that have more than 500 employees, it's up. It really hasn't changed. I mean, that upper trajectory is super strong.

If you look at it for companies in the sub-50 employee category, it's actually down. So there has been no growth over the past couple of years, and actually payrolls have started to roll back over in the second half of the year. So it does speak to, you know, to your point about this pressure on small businesses. It does speak to some of these sort of subsurface dynamics, again, where there is a lot of stress on the lower end, especially on the smaller end. But when you aggregate that and when you look at the aggregate picture of the economy, it doesn't show up as much because smaller companies are not bigger drivers of the economy in terms of profits, especially when we look at something like the S&P 500®, and even the earnings backdrop and the earnings outlook there. Small businesses are not going to show up in that. 

So there has been this split where you're just not able to see a lot of that stress. And you know, it's unfortunately, I think, something that probably continues going into the beginning of the year just because if you just look at the tariff backdrop alone, I mean, there's not really an expectation that we're going to see tariffs come down markedly. And when you think about tariffs squeezing the smaller end much more from a business, but also a consumer, perspective, that's probably going to continue. Even if the, you know, the emergency tariffs that the president has put on that are in front of the Supreme Court right now, even if those were to get struck down, you know, there's at least a plausible, certainly a plausible, route that the White House can take to put tariffs back on, just in a different manner. And they've said that themselves.

LIZ ANN: Speaking of tariffs and related inflation, so you've nicely summed up a lot of what we put in the outlook with regard to the labor market. But as it relates to the Fed to some degree, the other mandate of their dual mandate, aside from the labor market, is inflation. So maybe share some of the highlights around the inflation picture as we head into 2026.

KEVIN: Yeah. I mean, the inflation, if you just split it between goods and services, you can clearly see this year that goods has started to hook back higher, presumably because of, you know, upward pressure from tariffs. Part of that is also base effects. If you were looking at this on a year-over-year basis. So we're just sort of normalizing a bit. I will say, though, if you look at the core goods component of something like the Consumer Price Index, you know, the year-over-year change right now is actually … if you exclude the pandemic spike that we had in '22 and '23, the year-over-year change is actually pretty hot relative to history. So you'd have to go back to the '90s to see the kind of, you know, gains that we're seeing for goods prices. So I think that's worth keeping in mind because for a lot of the pre-pandemic expansion, we were actually in, you know … for a good chunk of time we were actually in goods deflation territory. So goods prices were for the most part actually coming down. It was the services side of the economy that was doing all the heavy lifting for inflation. Still the case today because services is a bigger part of the economy. 

But core services inflation is seemingly sort of hovering and averaging and landing around 3.5% in year-over-year terms. So that backdrop where you have services inflation staying that sticky and goods inflation seeing some more upward pressure because of tariffs that gives you an environment where it's pretty hard to get back to 2%.

So our outlook and the feeling is not necessarily that you go back to an inflation backdrop that we had a couple of years ago where you're starting to see really high single digits on CPI, but one that is probably going to be harder to get you closer to 2% just because of the nature of tariffs and the nature of the services economy.

LIZ ANN: One other area I wanted you to touch on and provide some highlights from the report before we shift gears to the market side of things is around AI, and maybe broad thoughts on capital spending, but how that ties into what has been obviously a boom in AI-related capex.

KEVIN: Yeah, I mean, the AI capex story has been so central to the economy this year and the trajectory of the economy, especially because, you know, when you strip out everything, you know, in terms of trade and in terms of consumer spending and you look at the portion of GDP this year that's been driven by business investment, you know, private business investment specifically on the technology side, it has been a significant driver of growth. 

And it's not necessarily that we think that narrow base of growth persists for all of 2026, but when you look at some of the dynamics in spending, you know, for data centers, which interestingly is a new subcomponent of private business investment that the Bureau of Economic Analysis has included over the past couple of years. But when you look at some of those rates, I mean, spending on data centers is up by almost 40%, you know, over the past year. Similar dynamic with computers and computer equipment up by more than 40%. That's really strong momentum that probably carries into the first half of the year. So I think the upside case from that is when you get these capex cycles, you know, they tend to lead to sort of broader, you know, bigger downstream impacts in terms of consumers being able to spend more because presumably a more beneficial backdrop for the labor market. It's just that we're sort of up against what I mentioned earlier in terms of more labor force, you know, pressure, downward pressure on labor supply growth, where I'm not so sure that we can create as many jobs as maybe would be the case if this was happening before we had more restrictive immigration policy. So there's definitely benefits to what's going on in the AI spending channels and all of the downstream impacts that we still expect. But I think you have to look at that in the context of a labor market that is just not as strong from a supply perspective.

LIZ ANN: I know I said one final area, but now I'm going to say it again. This time, really, one final area.

KEVIN: The real final area.

LIZ ANN: The real final. Talk a little bit about, there was a section in the report that we had called "Fiscal stimulus, but with a cost." So maybe thoughts on the One Big Beautiful Bill and its impact as we head in 2026 and whether there's any hope for any constraints on federal spending and the deficit and debt.

KEVIN: Well, the last part I can answer probably pretty firmly with no. I think that's a pretty high conviction call across Wall Street. No, I mean, you know, it's interesting. When I hear our peers in the industry talk about their outlooks for '26, I want to say that the fiscal stimulus notion is probably the most cited, usually the first one that people talk about in terms of, you know, tax refunds for consumers coming in the earlier part of the year, a lot of that being stimulus, but also on the business investment side, you know, the backdrop from the Big Beautiful Bill is pretty, you know, it's pretty beneficial. And there's so many estimates that are out there in terms of the boost to GDP, but the one that we included in the report comes from the Joint Committee on Taxation and then also the Congressional Budget Office and tax policy center where the estimate is that you get close to a 0.7% boost in GDP from the Big Beautiful Bill. But the cost that you talk about is that the trajectory for the federal debt, we show it as a percentage of GDP, but the trajectory is lifted much higher, not in a good way. So it sort of comes with the cost of this wider deficit year-to-year. And then overall you add that up, you know, a much larger debt pile.

So that's sort of the cost. But I think if you're just looking at '26 and you're just focusing on the growth outlook and the growth aspect, yeah, think net-net, it's certainly a benefit, not just on the business side, but to the consumer side as well.

LIZ ANN: So Kevin, thank you so much for joining us. We'll plug yet again our 2026 outlook because what Kevin shared today is but a snapshot of what is in the outlook and as always lots of visuals and additional commentary, but I think that was a pretty good overview of the economic side of the outlook. So Kevin, thanks so much for hopping on with us.

KEVIN: Yeah, thanks for having me, and thanks for all the chats this year. It was a good one.

KATHY: So Liz Ann, always great to hear from Kevin about the economic outlook. Very interesting takeaways because it is, I think, going to be very interesting year. What about the equity market now that we have the economic backdrop? What are your thoughts on the equity markets for 2026?

LIZ ANN: Yeah, so maybe I'll start, Kathy, by just blending a little bit of the macro, the economic, into the market and then launch from there. We have a sort of an eye-popping chart in our outlook, and it compares two consumer surveys. So the Conference Board puts out the Consumer Confidence Index, and University of Michigan puts out the Consumer Sentiment Index. And they're similar in that they're a gauge of the confidence or sentiment of consumers. But they have different sub questions that they ask. And there's different constituents that represent the survey base. 

But we've never seen anything like what we're seeing now, where the University of Michigan has a question about the expected increase in unemployment during the next year. And that has skyrocketed to about as high as you have gotten in the past looking at this data. Consumer confidence, which again comes out of the Conference Board, they have a question about expectations for stock prices to increase over the next year. And those are at an extraordinarily high level, that response. So you've got this big disconnect in these two surveys of … we have really dour expectations for the unemployment rate, but we have really robust expectations for the stock market. And I think that that's just a classic way to think about the K, where you're actually incorporating perspective on the economy versus perspective on the market. 

And some of it has to do with the survey respondents. The University of Michigan survey tends to be … their respondents tend to be more focused on kitchen-table kind of issues. And the Conference Board's respondents tend to be up the income spectrum; they tend to be more investment oriented. So that helps to explain the difference. But so there is still a decent amount of optimism about the equity market. And we're fairly optimistic about the equity market, too, although we expect it to come maybe a little bit more violently, a little more choppy, and one of the … maybe not reasons for that, but one of the factors in thinking we may have some more choppiness is the presidential election cycle, the four year cycle. And lots of ways to break this down. I've done it many, many times with looking at party control and election year to election year and inauguration to inauguration. And this is, though, we have a chart in the report that just is the four-year based on calendar year of the election cycle. 

So what we're exiting now in 2025 would be considered the first presidential year. And relative to the long history of the average action of the market throughout that four-year cycle, we significantly underperformed the norm in the first 4 months of the year in 2025, courtesy of concerns about tariffs and the turmoil that occurred and crescendoed in the early part of April. But then since that point, we've rocketed well above that norm. But what you do see in the long history of average cycle performance is you do tend to have a choppier pattern in the midterm year. It has historically the lowest percent of positive years at only 54%. In contrast, the next year, which is the third presidential year, has had, historically, 83% positive years. So that's something to be mindful of as a bit of a volatility driver.

I want to touch also and highlight some of the things that we wrote about with regard to AI. I have a visual in the report that has been making its rounds for more than a few weeks now, probably a couple of months now. It was a Bloomberg visual that was a great way to illustrate the concern about the circularity of financing with regard to artificial intelligence with, you know, not that we're covering or recommending individual stocks here, but sort of at the center of it, maybe no surprise, is Nvidia. You've got OpenAI representing an important sort of cog in this circular wheel, the likes of Oracle and AMD, and the concern is about the circularity of financing. And it harkens back to the late 1990s, where the term then was "vendor financing" and whether this is sustainable, where you have, at the core, some of the picks-and-shovels companies that are in turn investing in some of their customers, in turn sort of guaranteeing a shift back into the purchase of those goods. 

So that I think will continue to be an elevated concern in 2026. And I also think we're going to continue to see a lot more churn and rotation, akin to frankly what we started to see particularly in the second half of this year under the surface of the capitalization-weighted indexes. A bit more of leapfrogging that might happen within the market, especially within the AI space where you've got these groups of leaders and all of a sudden, whether it's a shift in focus on product or a bit of a you know, earnings or revenue disappointment, you get a little bit of a leapfrog effect where another faction of companies kind of leapfrogs and they suddenly find themselves in the spotlight and outperforming. And I think there's going to be a bit more of that in 2026. 

You know, with regard to the churn under the surface, you know, 2025 was a year where the cap-weighted indexes did well at the index level, but the fuller story was told under the surface. And already we're starting to see a bit of broadening out and greater participation, which I think is healthy from a big-picture equity market backdrop relative to an environment, which was more pronounced in 2024 than 2025, of only a few dominant mega-cap leaders driving the market and much more underperformance under the surface.

But just to use some recent numbers here to put this in context, over the past year, only 16% of the constituents within the S&P 500 have outperformed the index itself. But in the past month, that has jumped to about 50% of the constituents have outperformed the index. You can look at it on rolling one-month, two-month, three-month … in fact, we have a visual in the report that looks at the percentage of stocks outperforming the S&P over the past three months, but on a rolling basis, and the data goes all the way back to the early 1970s. And you can see that we've been sort of plumbing historical lows but have started to bounce higher. So I think there's been opportunity that has been created under the surface of these cap-weighted indexes. And then with some of the concerns with regard to AI: Is it a bubble? The circularity of financing?

I think what we're likely to see is less of a focus on these monoliths. One of the things we suggested in the outlook was that what has been a bit of an obsessive focus on the Magnificent Seven group of stocks, I think, will really start to fade. I think it already has started to fade to some degree this year because only two of the seven stocks are actually outperforming the S&P on a year-to-date basis and none of them are even in the top 25 best performers within the S&P. So I think you're seeing this shift in attention to where else can we find opportunities, not just within the tech and AI-related areas, but in other parts of the market. We recently relaunched our sector views, and healthcare is one of our favored sectors. We also have a favorable view on communication services still and a favorable view on industrials. So in our outlook is a link to our sector views where you can go in a lot more detail. 

Finally, we touch a bit on the earnings outlook. And the earnings outlook for 2026 is still fairly healthy. The consensus expectation is for growth that exceeds calendar year 2025 and that the majority of sectors are expected to have earnings growth greater in 2026 than 2025. But my guess is that the bar is set on the higher side and that when all is said and done at the end of the year, we probably don't see estimates exceed the original expectations to the same degree as what was the case in 2025. Valuation is still a concern, but there's some good news here for the bulk of the rally in 2025 off the early April lows up until about August. You were seeing generally an improvement in earnings expectations, but you had even more multiple expansion occur during that period of time. Now what we've seen since August, and I think this is likely to continue in 2026, is not much multiple expansion, but earnings continuing to accelerate, which is good news in the sense that that actually brings valuations down. That said, I think earnings will continue to have to do more of the market's heavy lifting. We can't really rely much on multiple expansion. Multiples are still high, but one of the things we conclude with in the report is that don't use that as a market-timing tool. 

Valuations don't tell you anything about what the market's going to do over, say, the subsequent one year period of time. It's more an indicator of sentiment than it is a market-timing tool. So I think it's a background concern, but it doesn't preclude the market from having another decent year. 

So that's it in a nutshell, obviously a lot more detail in the report. So Kathy, I'll toss it back to you just to see whether maybe you have some high-level summary thoughts in terms of the collection that you bring to the table of brilliant voices on our fixed income outlook.

KATHY: Yeah, and we will hear from those brilliant voices in just a minute. But from a high level, what we're expecting is solid returns in fixed income in 2026, maybe not as robust as 2025, where they've been quite good, mainly because there's less room for rates to come down from where they currently are. And that's largely due to the fact that the Fed has little room to cut rates much more because inflation has kind of stuck close to 3%. It's going to take more progress on inflation to get that down and to get the Fed to ease significantly more. And also because we have a lot of supply issues, not only with the federal deficit having to be financed, but because of this investment boom, there's going to be a lot more corporate bond issuance as well, a lot more debt for the markets to absorb. So given that backdrop, I think kind of steady rates this year, steady yields possibly coming down a little bit. There's a little bit of room for them to decline, but not a significant amount. And that means probably investors in fixed income are looking at earning the coupon, maybe a little bit more, but not a robust return simply because the starting yields are lower than they were last year.

Well, I'm happy to welcome Collin Martin and Cooper Howard, my colleagues on the fixed income team, back to the show. They've each been on a couple of times, so you'll probably recognize their voices. We're going to discuss our outlook for the fixed income markets in 2026.

So welcome, Collin.

COLLIN MARTIN: Hi, Kathy. Thank you so much for having me back.

KATHY: And welcome, Cooper.

COOPER HOWARD: Hi, Kathy, appreciate being here.

KATHY: Oh, and just a reminder for the listeners, you can find a written version of our outlook on schwab.com/learn, along with all the rest of our regularly published material.

So I'm going to start out just with a quick kind of high-level macro view on the Fed and what we think about the direction of Treasury yields, and then we're going to get into the conversation more deeply and talk about both taxable and municipal bonds.

So just to sort of set the stage, I think our takeaway is that we do expect the Fed to cut rates, probably with the fed funds rate getting down to about 3.25% to 3.5% by mid-2026. That's a couple of rate cuts. It may take a while, however, because inflation does remain a sticking point. It is a lot closer to 3% than it is to the Fed's 2% target, and I think that would probably signal that the Fed will go more slowly. And there are pretty deep divisions at the Fed about where policy should go, and that probably will slow things down.

But basically, the economy is doing OK. You know, trend GDP growth is looking solid going into 2026, and we'll get a little bit of a fiscal stimulus from the One Big Beautiful Bill. There's both expensing for investments, or corporations, in there and tax cuts for higher-income households. So that's a pretty solid fiscal backdrop for the economy. The problem is, of course, unemployment and job growth has slowed down materially from what we can tell, and the unemployment rate is just sort of creeping up. It certainly isn't at a high level yet, but it is an indication that the labor market is probably stalled right now. So I think that keeps the Fed in sort of a cautious state moving forward. And then finally, there's the wild card of potential changes at the Fed with Fed Chair Powell retiring in May and the annual rotation of governors and a few other potential changes. So all that means most likely we'll see a divided Fed, slower moving.

In terms of the takeaway for yields, I think our view is we expect a steeper yield curve, meaning that long-term rates will stay elevated even as the Fed cuts, but short-term rates will come down. I think 10-year yields are going to have a tough time falling much below 4% unless we really can get inflation down.

So with that backdrop, I'm going to go over to Collin first. Talk about the taxable bond market, and just give us kind of a high-level summary of your views.

COLLIN: Well, building on what you said, fundamentals are relatively strong. There are some tailwinds for the economy right now. It's been growing, you know, at or above trend lately, and there are some things with, you know, potential fiscal stimulus that can keep that going into 2026. So that's a good thing.

What concerns us a little bit from a big picture are just the relative yields you earn when you're thinking about different parts of the bond market. There's degrees of risk when we think about credit. You have investment-grade, then you have high-yield, which is lower credit ratings. You have preferred securities, which kind of have a different risk profile. So our main concern is the extra yield that we, as investors, are earning to take those risks today. So we're not saying you need to avoid the riskier parts of the market, but we are focusing more on those higher-quality investment-grade rated corporate bonds, because that's where we see a better balance of risk and reward.

KATHY: So in the corporate market, your takeaway is to still stay up in credit quality.

COLLIN: That's right. So the area that we've been focusing a lot on lately, Kathy—you know, at least a year, maybe two years now—are investment-grade corporate bonds. When we talk about investment-grade corporate bonds, those are corporate bonds with ratings of AAA down to BBB. So below BBB is what's known as the high-yield bond or junk bond universe. We like investment-grade corporate bonds because they have those high credit ratings for a reason. So from a credit risk standpoint, it's more low-to-moderate credit risk, and we think fundamentals are actually pretty strong right now.

If we look at corporate profits—we don't just look at S&P 500 or something like that. We look at more of an aggregate picture of corporate profits that we get from the Bureau of Economic Analysis, and they've been holding flat at around $4 trillion for the past few quarters. They've kind of … the growth has slowed, but the level, I think, is important because if companies have a lot of money, if they're making a lot of money, that means they can better remain current on their liabilities and remain current on their interest payments, maturity payments, things like that. 

We have seen an improving credit fundamental story with investment-grade corporate bonds. We've seen the makeup of the index, of the market, shift a little bit—where for a while, a big story of the investment-grade corporate bond market was the share of BBB-rated bonds, which is the lowest rung of that investment-grade credit spectrum. It had been increasing basically since the financial crisis in 2008, 2009, and then it peaked at a 52% share of the overall index, the Bloomberg U.S. Corporate Bond Index, in 2019. Since then, BBBs have been coming down at the expense of single As, which are higher credit ratings. So we've seen the average credit quality of that index improve a little bit over time. So that's a good thing. So if you're considering an index-based corporate bond investment, the underlying credit ratings of those holdings have been improving for the past few years. So that's a good thing.

KATHY: Quick question there for you, Collin. Is that because more companies have been upgraded over that time period, or is the composition changing because of new issuance?

COLLIN: It's probably all of the above. There's a lot of factors that go into that because sometimes you can see a BBB-rated issuer get downgraded to BB. That's not a good thing, of course, but that can kind of shift the makeup there. But upgrades have been a key driver. So the downgrade to junk is probably one of the smaller reasons.

One thing we've seen for about three years now are really strong upgrade-downgrade ratios in the investment-grade corporate bond market at both Moody's and Standard & Poor's. They've been upgrading way more investment-grade corporate bonds than they've been downgrading over the past few years. So mostly for good reasons. Some of it could be new issuance, but just a lot of it does have to do with upgrades from the rating agency. So that's a really good story there.

But then more importantly, the yields are attractive. I think that's what we want to focus on. The listeners here, you're focused on what kind of income payments can you expect—what's your yield to maturity or yield to worst, which is the lowest possible yield you can earn from an investment barring a default? And if we look at the broad investment-grade corporate bond landscape, you can get yields in the 4.25% to 5.25% area, depending on the actual maturity, depending on the credit rating. But we think those are pretty attractive relative to where we were in the, say, 12 years coming out of the financial crisis. Basically, before the Fed began to raise rates in 2022, you didn't really see yields this high. So they're still attractive right now.

And the slope of the yield curve, meaning what can you get by considering intermediate and longer-term maturities relative to short-term maturities, with investment-grade corporate bonds, it's a nice positively sloped yield curve—and it's more positively sloped than Treasuries. So if you're looking to focus more on intermediate-term or maybe you're looking for some long-term bonds, we don't suggest investors take on too much interest rate risk. But if you're looking to lock in some high yields for longer, you are rewarded with marginally higher yields by considering some intermediate and longer-term maturity. So we think it's a really good balance of risk and reward, improving credit quality, but yields that are still at the upper end of their 15-year range.

KATHY: Great, I'm going to skip over to Cooper here quickly and then come back to you and ask you about some of the other categories—high yield, preferreds, mortgage-backed securities, some of those other things.

But I want to pull in Cooper here quickly because I know a lot of our listeners are municipal bond investors, and it's always one of those areas we get a lot of questions on. So Cooper, tell me, what was the big story in the muni market in 2025, and what do you think about 2026?

COOPER: Of course. Well, the big story in 2025, I think, was just that—big—and it was the amount of issuance that came to market. So was a significant amount of issuance that was issued by state and local governments because, like you mentioned, a municipal bond, it is just a bond that's issued by a state or local government, usually to fund some sort of an infrastructure project or something of that nature. And if we look at the amount of issuance year-to-date as of 2025, it's about $550 billion, Kathy. If we were to push that into context, the average from 2010 all the way to 2023—and I've excluded 2024 because 2024 was also a big issuance year—that's about $350 billion. So we've issued $550 billion this year, average $350 billion.

Some of that's because, one, infrastructure costs are just higher now that inflation is higher. Also, the amount of voter-approved debt, it was elevated over the past few years. So that's starting to come to fruition. And what that means for the muni market, the muni market tends to be dictated by supply and demand. So if there's a significant amount of supply that's out there, and there's not as much demand for it, you'll see prices come in a little bit lower, and yields move a little bit higher as a result. And so because of that, munis have been one of the worst performing major fixed income asset classes that we tracked this year.

Now, looking into 2026, I do expect that the issuance story is going to continue to be a story carrying into next year. It's not likely that inflation is coming down anytime soon to make infrastructure costs much cheaper. Also, we are sitting on a significant amount of voter-approved debt, so municipalities are going to tap into that, likely use that. If the expectation, like you had mentioned, is that the Fed is going to cut interest rates, that should bring down some borrowing costs on the short end of the yield curve, help to drive some of that issuance. So I don't see this as a story really going away. And I think that that's going to be the big story in 2026 to watch.

Now, do we think that munis will trail all other major fixed income asset classes? I think the big key to that is what is demand going to be? So far this year, demand's been pretty strong. One of the metrics that we look at is just how much money is flowing into mutual funds and ETFs—and that's been positive going all the way back to April of this year. So that's when there was the big initial tariff rollout, a lot of concerns in the fixed income market. But so far over the past couple of months, it's been pretty significant demand. And I wouldn't be too surprised if that carries forward into 2026 and therefore is relatively supportive of total returns.

KATHY: Yeah, it seems to me that demand for munis is usually pretty solid. I mean, it's highly unusual when people say, "Gee, I don't want tax-exempt income." It's only maybe when there's more attractive alternatives out there that they might switch. But in general, it seems to me that the market absorbs issuance reasonably well under most circumstances.

COOPER: I would agree.

KATHY: Yeah, so one other question, and then we're going to switch back to Collin. Where do you see the opportunities in the muni market next year?

COOPER: Yeah, so there's two things that I'll highlight. First off is just the opportunity overall in the municipal bond market. Collin had mentioned attractive taxable yields for investment-grade corporate bonds of, say, something like four and a quarter, five and a quarter, depending on which maturity you're looking at. Now within the muni market, the average in the Bloomberg Municipal Bond Index, the yield to worst on that index is about 3.6%. So yes, it is lower than a corporate bond, but that's because munis generally pay interest income that's tax exempt. If you were to adjust it for a taxable bond for an investor who's in that top tax bracket, Kathy, that's about above 6% right now. So we do think given the average credit quality of municipalities, that's pretty attractive. And that's not just because that's for an investor in the top tax bracket. We can even adjust that for a little bit lower of a tax bracket. And if you look and compare the average yield of the corporate index to the average yield of the muni index, an investor would only need to be in a 20% tax bracket to make munis yield more than corporate bonds after taxes. So I'm not saying that every investor who's in a 20% or above tax bracket should consider munis, but it is something to show where valuations are and where the opportunity is overall.

Second piece of an area of opportunity in the muni market is for those investors that want to get a little bit more tactical. And I think there's an opportunity with longer term municipal bonds. Now, again, we're not suggesting everybody go out and buy 20-, 30-year municipal bonds, but the slope of the yield curve, like the corporate curve, is positively sloped. So you are getting a higher yield the further out you go. Also, the difference between the yield on a municipal bond and that of a Treasury after adjusting for taxes begins to increase further out the yield curve you go. So we do think that for investors who are a little bit more comfortable taking on longer term bonds, taking on that duration risk, because if rates rise, prices drop, it's likely that longer term bonds will feel that much more than shorter term bonds. For those investors who can stomach that interest rate risk, we do think that longer term munis are worth a second look.

KATHY: You know, and I want to note that our broad suggestion is that investors keep sort of an intermediate-term-duration average in the portfolio. That doesn't mean every bond has to be maturing in five to seven years. What it means is you can have a portfolio with some very short-term, some intermediate-term, some long-term. It should probably average out in that intermediate term. And the reason is that we see both interest rate risk potentially on the horizon and reinvestment risk, meaning short-term rates, coming down. So to kind of balance out those two, we're sort of trying to aim down the middle and keep that intermediate term average duration. But that can include some opportunistic investments elsewhere. 

So Collin, back to you. I wanted to ask you about some of the other sub-asset classes in the taxable market that you focus on. So we could talk a little bit about high-yield. I know that you're still pretty cautious because the valuation's not that great. But what about preferred securities? That's been an area that we previously liked and then kind of went neutral on. And then I wanted to ask you about TIPS, Treasury Inflation Protected Securities, as well. So take it away.

COLLIN: Haha, let me talk about preferreds first, Kathy, because that will tie in with Cooper's comments there about potential tax advantages. So preferred securities, they're a very unique hybrid sort of investment that they share characteristics of both stocks and bonds. So step one, if you are considering preferreds, understand how they work. They tend to have long maturities or no maturities at all.

But the key point with preferreds, and this is where I want to build on Cooper's comments, a lot of preferreds, but not all of them, pay qualified dividends. And so therefore they're taxed at a lower rate than traditional interest payments. So I think that's really important when you're considering investing in bonds. It's always important to look at what sort of accounts you're focusing on. Are you in a taxable account? Are you in a tax-advantaged account? So for fully taxable accounts, preferreds that make qualified dividend payments can make a lot of sense because of those lower tax rates.

And when you look at them on an after-tax basis, just like Cooper was saying how attractive munis look relative to corporates when you compare tax advantages, preferreds can offer higher yields than even high-yield bonds when you consider the tax advantages. Now, every individual's situation is going to be a little bit different. You have to make sure you're focusing on preferreds that pay those qualified dividends. But the credit ratings of preferreds tend to be higher on average than with high-yield bonds. That's something to consider.

I did mention that they have a lot of unique characteristics. They tend to be more volatile. They tend to be correlated. They tend to have a relationship with both the stock market and long-term Treasuries. They get pulled in a lot of different directions all at once. So it's tough to be too tactical with them. But if you're a long-term investor and you're looking for potential tax advantages, and you can ride out the ups and downs, preferreds can make a lot of sense.

I want to take those comments and just build real quickly on high-yield bonds like you mentioned. I don't want to take too much time because it's not an area that we think there's too much of an opportunity. We talk a lot about high-yield bonds and bank loans, and we say you can consider them in moderation only, but we are a little bit cautious. I just want to differentiate. We are cautious. There are risks, but it doesn't mean investors need to avoid them altogether. It's important to just be cognizant of the risks there.

But our main concern with those riskier investments—and again, high-yield bonds, those have sub-investment-grade credit ratings, and bank loans have sub-investment-grade credit ratings—the extra yield you're earning when considering those investments is pretty low. It's very low today. So you're just not being compensated too well. And one thing we look at with high-yield bonds, it's called the spread. It's that extra yield that they offer above Treasuries. The average spread of the Bloomberg U.S. Corporate High-yield Bond Index, it's generally been 3% or less from July through the end of November. And when spreads are that low, it's difficult for them to outperform Treasuries. So from a tactical standpoint, it's tough to make the case.

If you are looking to take a little bit of risk in your portfolio and you do have a long-term investing horizon, we generally prefer high-yield bonds over bank loans today. One, high-yield bonds tend to have fixed coupon rates, where bank loans have floating coupon rates. So they are much more sensitive to changes in Fed policy. So if the Fed cuts rates, the income on bank loans may decline. So that's one reason. And high-yield bonds tend to have higher average credit ratings. So if defaults pick up, that might impact the bank loan market more than it impacts the high-yield bond market. So we're a little bit cautious. You can consider them in moderation. But if you are looking to take some extra risks today, again, in moderation, we'd prefer high-yield over bank loans.

And then Kathy, at risk of me rambling a little bit, I believe you asked about TIPS. 

KATHY: Yeah, I wanted to ask about TIPS just because there's so much concern about inflation. And one question we get all the time, as you know, from clients is, "Well, how do I invest to offset the inflation risk, because for bonds, inflation is not a good thing?" So that's where the story about TIPS comes in. So I wanted to ask you about that.

COLLIN: Yeah, I think TIPS are pretty attractive right now. I know that investors and consumers alike are pretty much always worried about inflation. But right now, inflation is high. Admittedly, if you look at the Consumer Price Index, the CPI, or the Index of Personal Consumption Expenditures, PCE—those are two of the main inflation indexes that we track—they're both well above the Fed's target of 2%, but well above levels that we were seeing for, really for years except for the past handful of years. And as you mentioned, if you're in a bond investment with a fixed interest rate, inflation just eats away at that. TIPS can be a really nice way to protect yourself against inflation because their principal values are indexed to the Consumer Price Index. So as inflation rises, the principal value of your TIPS can rise as well.

When you look at TIPS, it's important to understand what those yields are. Those yields tend to be lower than the yields on traditional Treasuries, but that's because they're already inflation adjusted. So if you see a yield on a TIPS of say 1% to 2%, and you hold that TIPS to maturity, you would earn that yield, say 1% to 2% above the stated inflation rate, regardless of what inflation is.

So I think there's just … it's a really big benefit right now. We're in an environment where inflation's still high. We know it eats away at returns of all investments. And TIPS are one of the few investments that I'm aware of that is actually indexed to the Consumer Price Index. So if inflation were to stay elevated or worse, if it were to reaccelerate, I think they're an investment that can be very attractive right now and that you can lock in positive inflation-adjusted returns.

KATHY: Yeah, I like that. It's something a lot of investors reasonably really concerned about. And I like the fact that it's indexed to CPI, the Consumer Price Index, and that's the overall. It's not excluding housing and food and energy and all the things you actually spend money on. So it gives you kind of a broad-based, inflation adjusted metric, so that's very healthy.

Back to you Cooper. You know, Collin was talking about the volatility that can come from credit spreads, right? Are there concerns about credit quality and the municipal bond market? I sometimes get this question from investors wondering about the state of the finances in states, right?

COOPER: Yeah, the state of the states.

KATHY: The state of the states, right. So are you concerned about credit quality? Generally speaking, investment-grade munis haven't had a lot of issues with credit, but tell us what you think for 2026.

COOPER: No, you're right about that, is that one of the things that the muni market can really hang its hat on is stable credit quality. And that's in good markets, bad markets. Even if we look back at 2008, defaults were elevated, but they weren't anything near what was happening in the corporate market or the high-yield corporate market. So I do expect that piece of stable credit quality to continue into 2026. That's not to say that credit quality is nothing that you should focus on or that you should just completely ignore because there are differences in different types of municipal issuers.

And the way I like to look at it is the investment-grade municipal market versus the high-yield muni market. And we can discuss the high-yield muni market. I know I've been on these podcasts in the past discussing it, but I do think that that's really a different type of an animal. So I'll just focus in on the investment-grade muni market.

And over the past couple of years, we've actually seen an improvement in credit quality. Coming out of the COVID pandemic, that was really a big game changer for the muni market. There were a lot of concerns that municipalities were going to be faced with huge amount of defaults, everything was going to shut down. That largely didn't happen. And yes, it was five years ago, a while ago, but municipalities are still feeling the effects of what's come out of that.

One of the effects was there was a big surge in tax revenues. There was also a big surge in fiscal stimulus. So Congress poured a ton of money back into states. And largely speaking, states use that to build up their savings accounts. So for a state, a savings account is called a rainy-day fund, and it'd be akin to a savings account for you or I. If we see a decline in our revenues or a decline in our income, we might have to tap into our savings accounts. Some states are starting to do that, but overall, they're sitting on very, very healthy balances. So I do think that that provides a little bit of a runway going forward. If we start to see the economy slow, which that is in our base case, and we start to see revenue slow, which is in our base case, but if we do start to see that, then municipalities have this backup that they generally can tap into.

The other piece that I'd point to is that yes, municipalities can generally hang their hat on stable credit quality. And that's because most of the municipalities out there, the starting point in terms of credit quality is very high to begin with. So if you look at the Bloomberg Municipal Bond Index, which is a very big broad index of kind of many different municipal issuers that are out there, on average, about seven out of ten of the issuers in that index are either AAA rated or AA rated. Those are the two top rungs of investment-grade credit quality. So tends to be the bonds with higher credit ratings, they have higher credit ratings because they have more stable revenue sources, they have higher liquidity, et cetera. So a lot of that does provide, again, a good starting point going forward if we do start to see the economy deteriorate, tends to be that municipalities are already very highly rated.

And then the second piece is they're also sitting on very high liquidity positions, so that should bode well going forward.

KATHY: That's great. It's such a change from the concerns that we had a decade ago. So it's interesting how much the narratives have changed. Whether the facts have changed, I don't know, but the narratives have changed over the years.

COOPER: Haha. Yes, the facts have changed.

KATHY: Haha, OK. Well, sometimes the narrative changes and the facts haven't changed that much. But in this case, they have changed.

COOPER: Yes.

KATHY: So Cooper, let's wrap up the muni discussion with—what should investors consider doing in this market?

COOPER: Yeah, so I think that there's a couple action steps that individuals can consider, investors can consider. The first is do consider municipal bonds because of their tax benefits. But it's important to understand what type of an account you're invested in. Because if you're investing in something like a tax-sheltered account, whether it's an IRA or a 401(k), something of that nature, municipal bonds generally don't make that much sense.

So the second piece is also look at the after-tax yield. I know we mentioned earlier about what the yield on a broad index of munis is relative to corporate bonds. It's not necessarily what you take into your account. It's what you take home after having to pay taxes. So I think that that's an important piece.

Now, within the muni market, we do think that investors should stay up in credit quality. This also ties into some of the themes that we've discussed with the corporate market, some of the other themes that you've discussed, Kathy. Part of the reason is, even though we don't have too many concerns about credit quality in the muni market, it's just you're not getting that compensated for taking on that added credit risk. So by investing in the lower-rated portion of the muni market, of the investment-grade portion of the muni market, spreads right now are relatively tight. So we don't think that it makes that much sense because you aren't getting that much additional yield or additional compensation.

The other piece of it is yes, we do think that most investors should stick to a benchmark duration. And for the average municipal bond investor, that's about six years or so. But do consider longer term municipal bonds if you have the risk tolerance to stomach it, because that is something that could potentially offer higher yields. And if we don't see longer term yields rise that much or significantly, then those might perform fairly well compared to other parts of the media market.

So those are a couple takeaways that I think investors should consider.

KATHY: OK, thank you Cooper.

I'm going to go over to Collin now. Looking at the various asset classes and fixed income you cover, what do you suggest investors consider?

COLLIN: Our main guidance is up in quality, and luckily Cooper made that point really well in terms of even in the muni market, what are you getting compensated by taking additional risks? That's exactly how we feel with the taxable credit markets, and it's a key reason why we prefer, generally, investment-grade corporate bonds over high-yield bonds.

So far, year-to-date through early December, the total return of the Bloomberg U.S. Corporate Bond Index, that investment-grade index, and the Bloomberg U.S. Corporate High Yield Bond Index, they're very similar. And the high-yield bond index, it does have higher spreads, but there have been defaults over the years, so modest credit losses to kind of help neutralize those returns a little bit. We think that can continue.

If you're considering investment-grade rated corporate bonds over high-yield, there's not much of a downside, we don't think, to that sort of approach, because there's just very limited upside with high-yield bonds. So you're not missing out on much by favoring those higher-rated parts of the market. Now there could be opportunities down the road if we get an economic soft patch, if we get some sort of risk-off environment or maybe the stock market declines, maybe that would present an opportunity to be a little bit more tactical with the lower-rated parts of the market. But right now, there's just not much upside to doing that.

And then, I think most importantly with highly rated fixed income investments, whether that's Treasuries, investment-grade corporates, or even in the muni market, the starting yield gives you a pretty good idea of what you can expect from your bond investments, barring defaults. And if you're focusing on those higher-rated bonds, the default risk is pretty low. So if the yields you see, whether in munis and taxable accounts, whether it's corporates and tax-advantaged accounts, if they're going to help you reach your goals, we think there's still a lot of opportunity out there.

KATHY: That's great. And you know, one of the key takeaways is always that you have that starting yield is really important in determining your total return for the year. So it's going to be the yield plus or minus some price gains or losses. And I think a great example so far this year is that intermediate-term aggregate index, the Bloomberg Aggregate Index, is up north of 7% year-to-date. So that combination of an attractive starting yield, which is, I think, roughly around 5% at the beginning of the year, and some capital gains because yields have come down, has produced a pretty nice return. I like to say bonds are doing their job, they're holding in there, they're generating income, and they're providing some diversification from stocks—and, you know, that's what they're designed to do.

So thank you both. Been great having you on the podcast, and I'm sure we'll be talking to you more in the future in 2026.

COOPER: Thank you so much for having me, Kathy.

COLLIN: Yeah, thank you, Kathy. Talk to you in the new year.

LIZ ANN: Whew, well, Kathy, I know this has been a heck of a lot of material for our listeners, but it's also some of our most requested information. So to our listeners, thank you for sticking with us on this longer-than-normal episode. And if you've enjoyed this particular episode, please take a moment to leave us a review on Apple Podcasts or a rating on Spotify. And remember, check out Schwab.com forward slash learn to get the full written reports for all of our 2026 market outlooks.

KATHY: Also as a reminder, you can always keep up with us in real time on social media. I'm @KathyJones on X and LinkedIn. That's Kathy with a K.

LIZ ANN: And I'm @LizAnnSonders on X and LinkedIn. Those are the only sites that I am on. And I only say that because I still have lots of imposters. So please be wary of that. And we will be back with a new episode next week, which will be our final episode of 2025.

KATHY: For important disclosures, see the show notes or visit schwab.com/OnInvesting, where you can also find the transcript.