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.
Well, hi, Liz Ann. I actually got a chance to see you in person this week. We've both been at Schwab's advisor convention, annual convention in Denver, called IMPACT. And we both made it, despite the disruptions to air traffic because of the government shutdown.
But I think all the talk here, or a lot of the questions here, seem to be revolving around this lack of economic data and how we're navigating thinking about the economy at this stage of the game. So just saw the ADP numbers recently. We're at least getting that, unemployment. What was your takeaway on that data?
LIZ ANN: Yeah, so the headline of ADP was a gain of 42,000 jobs, which was a little bit north of expectations. And that, at least partly, offsets the declines that occurred in August and September. And that had raised some concerns alongside, of course, what were two weak government-issued Bureau of Labor Statistics jobs reports. The broader trend, though, still is relatively weak, notwithstanding the stronger gains here. If you look at the sectoral breakdown, it was relatively narrow concentration of where jobs were created. And that's sort of what is getting dinged in this report, is the narrow concentrations.
So the biggest job gains came in trade, transportation, and utilities. In the case of utilities, maybe not much of a surprise given the AI tie-in. Education and health services was second, and our industry, finance, was third. But you had job losses in professional and business services and a few other services categories, and employment and manufacturing fell, too. So that is getting some attention.
So trade, transportation, utilities was on the upper end of the spectrum, and information and professional business services were on the weaker end of the spectrum. And also for our listeners, ADP, which was always just a bit of a sidebar relative to the Bureau of Labor Statistics' non-farm payrolls releases, obviously taken on greater prominence given that we're not getting the latter, but ADP also announced last week that they are going to be doing weekly readings on jobs. So that is helpful in the data desert that we still live in and what is now the longest government shutdown in history. What are your thoughts on the labor market and maybe what it means for the Fed?
KATHY: Yeah, so I think that the numbers are probably just good enough to keep the Fed on hold for a while. It's very difficult to know what the break-even rate of hiring is supposed to be right now. We know that it should be lower because we've reduced the working-age population with the immigration policies. We don't exactly know where that number is. What level of job gains keeps the unemployment rate steady where it is? And we don't know, but I think there's a lot of estimation that it's somewhere around, you know, 30,000 to 75,000 a month. So this falls into that range so the Fed could look at that and say, "OK, we are adding jobs. It's not robust, but we're adding jobs and probably keeping the unemployment rate at fairly healthy level, still below 5%, which in the past was considered full employment."
Meanwhile, you know, we still have high inflation. We still have uncertainty over tariffs. And I think it's important to remember that the Fed only has so much room to cut rates if inflation doesn't come down. They can anticipate slower growth and lower inflation. But until it happens, if they keep reducing the fed funds rate, they're going to be right on top of the inflation rate or under. And that's going to give us negative real interest rates, which is certainly not what the Fed wants to do.
So I think these numbers, the government shutdown, probably reinforces for the Fed that they're on hold, we think, through the end of the year, maybe a couple of rate cuts next year, assuming the economy slows enough to bring inflation down. But there's so much policy uncertainty right now that I think they're definitely in the go-slow mode right now, feeling that they've gotten rates low enough that they're not constraining the economy with high interest rates.
LIZ ANN: And you know, Kathy, one of the other issues, too, is that I … in fact, I had a couple of conversations at IMPACT last evening with people that were just saying, "Well, when the government opens back up, we'll right away start to get a stream of data." The problem is the government's shut down now for 36 days. So the data gatherers are not there. The administration already suggested that there won't be an October Consumer Price Index report. And we know that the Bureau of Labor Statistics, other than being called back in for a few days to calculate September's CPI, hasn't been collecting the data for the Establishment Survey, from which payrolls are generated, and the Household Survey, from which the unemployment rate is calculated, which means that even when we start getting this data, it's probably going to be fairly messy data.
I think it's going to take a while before we actually have a stream of data points that is kind of up to snuff in terms of the comp to pre-shutdown era.
KATHY: Yeah, I mean, it's kind of unprecedented that we've gone this long without gathering the data. And I think it really does put the markets kind of on edge to some extent, because … certainly the bond market is just holding this equilibrium, just kind of sitting here waiting for things to happen. But we did get another interesting piece of information, and that's the announcement of the quarterly refunding.
I never make too big a deal out of this, because I think in the broad scheme of things, it's not that significant. But we are focused a lot on the composition of Treasury issuance these days. And what they've said is they're going to continue to issue a lot more short-term paper, more T-bills than coupons and bonds for the time being, well into next year. And so what we're looking at is a Fed kind of trying to figure out, "Well, what is that going to mean for rates as well?" And how does that affect the overnight repo market, and what the Fed needs to do to deal with that? But I think for the market, it signals that Treasury continues to want to forecast lower long-term interest rates.
But I don't think the market is fully on board with that. So we're going to see a little bit of push-pull, I think, on some of these auctions to try to figure out where rates should be. So it's going to be a little bit more interesting than it has been in the past. The other thing that's kind of giving the market jitters, of course, is earnings. And we've had a little, what are they called? The yeeps or something?
LIZ ANN: Yeah, the yips or yeeps. Yeah, I think it's the yips.
KATHY: The market got a little yippy, I guess, the stock market with earnings. So I wanted to ask you about that. I thought that was pretty interesting.
LIZ ANN: Yeah, so in the aggregate, earnings have been quite strong. So we're looking at what's called the blended-growth rate, combines the actual earnings of companies that have already reported with the consensus estimates for those yet to report. And that's running at about 14%. And you've got a near-record beat rate. But there's more dispersion that's occurring. Even among the Magnificent Seven, you had five of the Mag Seven report last week, and three were seen as strong reports, and two were not. So even within the Magnificent Seven, you're seeing more dispersion.
And some interesting themes coming out of earnings season. One, if there's one benefit to having a long government shutdown in the data desert that brings with it is that we're in earnings season. So that gives us a bit of a macro overview, especially given that financials are typically first out of the blocks and they often talk about the health of the consumer. And now with the tech space reporting, we'll get a further sense of artificial intelligence, capex spend. And I think some of the takeaways, and maybe some of the reason for the yips in the market … well, part of it is the famous or infamous Michael Burry of The Big Short fame. I joked last night, "He has entered the chat," and then Kevin added a little funny to that and said, "Maybe he entered the ChatGPT," in having taken a very large short position in both Palantir and Nvidia, and that caused some concerns. I think the broader concerns, including of course, valuation, stretch valuations, but as we often say, that's a terrible market-timing tool.
By the way, I'm not about to tell you what is a great market-timing tool. It's just valuation is on that long, long list of things that are not market-timing tools. But the eye-popping size and growth rate in capital spending, concerns about the circularity of capex, where that does harken back to the late 1990s, what was called at that time "vendor financing" and the loop of "We'll invest in you, and then you'll continue to buy our chips," and the circle goes round and round. And you know, ultimately, with the bursting of the bubble, it took down at least at that time, the likes of the Ciscos of the world. So there's concern about the sustainability there. Where you are seeing some stocks get punished is if they talk about some margin pressure, especially within the tech space.
There's also starting to be more deals announced that are debt-financed. Not a huge surprise there because the growth rate of free cash flow, just among the Magnificent Seven, has gone from more than 60% six quarters ago to now two quarters in a row of negative. This in and of itself doesn't mean Armageddon by any means. It's just a different backdrop, relative to the period up until recently when this boom … maybe let's not call it a bubble yet, has been equity financed, has been financed out of cash flows.
So I think what we're seeing in earnings season is just maybe a bit of a heightened amount of sensitivity. You're seeing the misses, companies that miss, disproportionately punished, and even the mild beats are not getting terribly rewarded relative to market overall market performance. The stocks that have done incredibly well in the immediate aftermath of earnings season have been the huge beats. So I think the margin of error has maybe changed a little bit, and that's something that's come about this earnings season.
KATHY: I think just my observation is with anything, any investment, the price you pay becomes important. So a lot of people love to talk about the underlying fundamentals, but the other component is valuation. It's like the price you pay ends up really being a big determinant of what your ultimate return is. And that's the way we think about the credit space is, are you getting compensated for the risk that you're taking?, How much are you paying for that extra yield that you're getting? And we're seeing some slippage in the credit markets right now as well. A little bit of widening of those credit spreads that have been so, so tight for so long. So I think that that's kind of a reflection of some of those concerns as well. Can companies continue to put up the big numbers that they've been putting up?
LIZ ANN: Yeah, and that brings up another point as it relates to the equity market. I think we may be in the beginning of an interesting phase here where you had seen in September and October a pretty robust pickup in terms of performance down the cap spectrum. But until recently, a lot of that enthusiasm and actually market performance was way down the quality spectrum into the non-profitable segments of small caps, into the zombie companies, which are defined as those companies not having sufficient cash flow to pay interest on their debt. And we've got a big maturity wall coming for the zombie companies in 2026.
And I think the combination of that and the fact that, alongside cap-weighted indexes having done extraordinarily well since the closing low on April 8th, there's been a lot of churn and rotation under the surface. You know, the average member within the S&P 500® just since the boom, since April 8th when the S&P, I think, is up, you know, 36%, 37%, since that point the average member within the S&P has had a 16% maximum drawdown, and it's 35% for the Nasdaq.
Now that highlights this rotation, but it also highlights that some opportunities have been created outside of these prior, or maybe ongoing, in some cases, leadership names. And I think that's maybe a shift we're going to see is, to use trader lingo, sort of a "fade" of that ultra-low-quality zombie companies, which to a large degree was a bet on a continuation of easing policy by the Fed and a search for opportunities in other areas of the market. So that'll be something that we'll write about in more detail in our 2026 outlook.
KATHY: Well yeah, I mean, real interest rates are still positive. And if the Fed continues to hold the line, as I think they will, until they see some real progress on inflation, you're not going to see that ultra-low interest rate again to fuel speculative activity. But remains to be seen, obviously.
Any final thoughts on the markets here as we try to figure out what's going on?
LIZ ANN: Yeah, you know, the data desert we're still in, but we are getting some data. We already talked about ADP. In about a half an hour, relative to when you and I are taping this, we'll get the Institute for Supply Management Services (or non-manufacturing) Index. And as a reminder, the manufacturing part of that pair of indexes came out, and that was a bit weaker than expected. We're also getting Challenger job cuts. So again, in the absence of getting government-issued, Bureau of Labor Statistics–issued data, I think a lot of those job releases of any variety will matter. And as far as the market is concerned, I think we'll continue to see this churn. And the ideal situation would be, if we had a continued pullback on the part of many of the Mag Seven, AI-space, mega-cap tech, whatever terminology, whatever cohort you're looking at, that we start to see maybe some grinding better participation from the so-called soldiers relative to the generals. So I think we're not without opportunity in the equity market.
KATHY: You know, I'd say the same thing on the fixed income side, that it's been quiet with yields just kind of steadily holding in a range. I do think that eventually we'll see them come down a little bit from here, but not as much as maybe the market has priced in. But the good news is the coupons are very attractive.
And the volatility has been relatively low, which is good news for investors. So if you're sitting in a portfolio with some allocation to equity, some to fixed income and whatever other categories, fixed income is kind of doing its job right now. And that's the good news. We've got really good returns year-to-date in every subcategory of the fixed income market. And that's the good news.
LIZ ANN: Fixed income doing its job.
KATHY: It's doing its job. It's boring. It's not nearly as much fun as the stock market right now. But I prefer when it's not yippy. So it's been good.
So that's it for us this week. Thanks for listening. 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. Still have lots of imposters. Last time I looked on X, it was two and a half pages worth of imposters. So be mindful of that. And also a reminder, you can read all of our written reports, which are always chock full of charts and graphs, as are our feeds, social media feeds. And you can find those written reports at schwab.com/learn.
And if you've enjoyed the show, we'd be so grateful if you would leave us a review on Apple Podcasts or a rating on Spotify or feedback wherever you listen, or tell a friend or more about the show. Thanks for listening, and we'll be back next week.
KATHY: For important disclosures, see the show notes or visit schwab.com/OnInvesting, where you can also find the transcript.