What's New in Stock Sectors & Corporate Bonds?

LIZ ANN SONDERS: I'm Liz Ann Sonders. 

KATHY JONES: And I'm Kathy Jones.

LIZ ANN: 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, Kathy, last week you mentioned we'd get plenty of Fed-speak to decode. So let's focus on initially Jay Powell. What did the bond market make of his latest comments? And do you think there's a new consensus on where the Fed stands this week, which seems to be a moving target every day?

KATHY: I think they've coalesced around this message of patience. So they've extended the timeline that they're on hold, presumably, and encouraging everyone to be patient, to wait to see when they get enough data to suggest that inflation is coming down towards the 2% target, and therefore they can think about cutting rates. So no change in the basic outlook, but definitely an extension of that timeframe, that X-axis, if you will, has been moved out. So now I think the market is pricing in about one to two rate cuts in the second half of the year, which is certainly closer to where the Fed's guidance was at the beginning of the year, which was three.

But it's very far from the six or seven that had been priced in for a while. So we see short-term rates, 2-year yields, up around 5%. That's discounting higher for longer. Long-term yields have come up as well, but we're still in an inverted yield curve because there's still that expectation that the next move will be a cut. What about you, Liz Ann? What are you seeing in terms of earnings? We got a lot of churn in the stock market lately.

LIZ ANN: Yeah, we sure do have churn. It's a little early to come to too many conclusions in terms of earnings season right now. What they call the blended growth rate, which is a very small percentage of companies that have already reported those actual results blended with the consensus estimates for companies that have yet to report. And that's running at about 2.7%. But again, it's too early to make a judgment as to whether we'll end this season with a better-than-average beat rate and percent by which companies are beating. But you are seeing, and maybe it's because we're just in a churnier, choppier market environment right now that the stocks missing get more severely punished relative to the gains accrued to the stocks that have beaten. And I think that's something to keep an eye on throughout the season. But to your point about a churn, there's a table I put on my Twitter feed every morning that looks at the four major indexes, the S&P, the NASDAQ, the Russell 2000, and the Dow, and looks at things like index maximum drawdown and year-to-date return. 

Using the NASDAQ as an example to highlight this churn and a bit more weakness under the surface than what you'd pick up if you just looked at the index levels, the NASDAQ has had about a 4% drawdown from the year-to-date high, but the average member within the NASDAQ has had an average maximum drawdown of 31%. So a lot more extreme weakness under the surface. That tends to be biased down the cap spectrum, and you see something similar. The average Russell 2000 member has had about a 24% drawdown. So a lot of churn and rotation under the surface that is not suggested if you're just looking at the index level. And it wouldn't surprise me to see that kind of environment maintain itself. And I think the reason for more weakness down the cap spectrum is very much to your comments, Kathy, about the move up in yields and the greater sensitivity that some of the smaller companies have, especially the zombie-type companies that don't have sufficient cash flow to pay interest on their debt, let alone have the worry about debt coming due and having to roll over at higher yields.

KATHY: Yeah, there's that expression, you know, "survive until '25" for these smaller companies that have a lot of debt. So I can see that that's probably weighing on them at this stage of the game.

LIZ ANN: So Kathy, this week we're talking about two different ways to invest, on my side of the world and your side of the world. So through sectors, through equity sectors, and corporate bonds. And we have some key updates in both of those areas. So starting with you, tell us why you wanted to speak with your, our, colleague Collin Martin about the corporate bond market this week.

KATHY: Well, Collin, of course, this is his real area of expertise. And we've been, as you know, favorably inclined towards investment-grade corporate bonds for investors looking for yield without a tremendous amount of credit risk. And wanted to get an update from him on what he's seeing there and our point of view and answer a couple of questions that we've gotten from investors. Liz Ann, same question to you. Tell us about why you wanted to talk to Kevin this week.

LIZ ANN: Well, I'd say within the equity side of things, we always are getting questions about sectors. And as hopefully many listeners know, earlier this year, we relaunched what we call Schwab Sector Views, where we have actual ratings. And they're termed with outperform, marketperform, or underperform on all 11 of the S&P equity sectors. So it's always top of mind, and Kevin is very much our point person on sectors, so I thought an update especially given as you and I already discussed some of the churn in the market and the leadership shifts with a bias more toward those classic cyclicals that have been leading areas like energy and materials, so I thought it was timely to have a convo with Kevin.

So joining me now is my colleague and friend and right hand, Kevin Gordon. Kevin is a director and senior investment strategist here at Schwab. And in addition to providing analysis on the U.S. economy and stock market for Schwab's clients, he also helps develop deep-dive projects as well as content for Schwab's public website, our internal business partners, social media outlets. He is a frequent guest on CNBC, Yahoo Finance, Bloomberg TV, CBS News, has been quoted in TheNew York Times, Forbes, MarketWatch, CNN, The Wall Street Journal, Bloomberg, and Financial Times. 

As always, Kevin, thanks for joining us.

KEVIN GORDON: Thanks for having me, good to be back.

LIZ ANN: Glad to have you. Love our conversations. I guess not really on camera, on microphone and off. 

KEVIN: On microphone. Exactly. 

LIZ ANN: As many listeners know, because Kevin has come on the program before and talked to us a bit about sectors, he is our man on the ground, on the air, on sectors, our point person. So that's what I want to focus on a little bit today, as also probably most listeners know it's been a little bit choppy in the market, depending on which index since the latter part of March into the beginning of April, so call it the last couple of weeks, a variety of culprits behind some of that volatility. But, in particular, Kevin, what sector trends and changes have been notable since we started this period of a bit of downside, some consolidation, and some volatility? What are your thoughts on some of those sector trends in what you're seeing?

KEVIN: Yeah, it's interesting. And you and I just wrote about this a couple of days ago and published it. It went out publishing yesterday about some of these trends. And we kind of, in the report we put out, which is called "Family Affair," it's just a look at sector trends. We looked at kind of the two-month period so far, if you were to split the four months that we've seen so far, almost four months this year. And January, February looked a lot different than March and April have looked, where you started to see the split where January, February was, for the most part, if you were just looking at sectors, kind of dominated by what had done really well, you know, over the past year. Technology, communication services, it was kind of the heavyweights that were leading us again, but then that really started to shift in March and in March I think one of the most stark shifts that we saw was the energy sector really just coming back up and taking the leadership baton pretty much away from the tech sector. 

So if you look at the performance breakdown for January, February for energy, you know, very minimal gains at all and substantial gains for tech. That has switched since March. So it's been a really interesting change where you've had this consistency and leadership for a sector like communication services, which has kind of kept the crown the whole time in first place. But then for another, you know, sector that's typically considered in the growth family, which is tech, that's kind of taken a backseat now to energy. And a lot of people would point to that and say, "Oh, that's kind of a reflation trade." It makes sense because we've seen relatively hot or sticky inflation data over the past few months.

But that also doesn't fit as well with communication services still outperforming. But at the same time, and we talked about this a lot, just the top heaviness of some of these sectors, one of the reasons that communication services has done really well is because you look at the two largest names in that sector, Meta and Alphabet, and you know they've been on a tear, Meta more so than Alphabet this year, and given they make up you know almost two-thirds of that sector, it's not a surprise to see why it's done so well. And I like to point that out because it's kind of this perfect example of two stocks in the index really driving the gains because, as of a couple of days ago, you only had half of the communication services index trading above their 200-day moving average, half of the members trading above their 200-day moving average. So when you compare that or square that with the performance that you've seen, it's sort of been heavily distorted, but it kind of gets to the whole thing what we've been discussing this year, the whole topic or you know this environment of a lot of chop and a lot of churn, it just hasn't really made its way to the surface because there have been names that have at times done really well and sort of kept us going higher. So it's been an interesting shift. Where it hasn't been a definitive, you know, reflationary trade, all of the cyclicals are leading, you know, the deeper cyclicals where growth and defenses have taken a backseat. It has been more of a mixed bag lately. So if you're diversified in those areas, it's been great. But if you have kind of more exposure towards an area like tech, you probably haven't felt as good over the past month and a half.

LIZ ANN: Yeah, I think a lot of investors are aware of the top heaviness in segments of the market, like technology, but that's also the case in energy. So talk about the top heaviness in that sector as well, given that it's been a strong performer.

KEVIN: You take the two largest stocks there—it's Exxon and Chevron—it's about 40% of the index. So it's really interesting because the four sectors that have that top heaviness, if you were just taking the two largest names in each sector, and I'm talking about energy, communication services, then tech of course, and then consumer discretionary. So communication services has the largest concentration for the two largest stocks in terms of their percentage of overall market cap. Energy is the lowest there, but still it's about 40%. Then you have a huge dropoff to the other sectors. They're a lot more equal. You don't really have to look at the distortions from the two largest names. But energy is a sector where, yes, you do have the top heaviness, but at the same time, it scores the best right now at least as we're having this discussion. You know maybe it can change later this week because things change fast these days. But you know, you look at the percentage of companies that are either trading above their 50-day moving average or their 200-day moving average. You look at the number of new highs that the energy sector has made over the past few weeks.

All of that has been supportive of sort of a broader rally taking hold for energy. And actually, what was interesting is that if you look back and you look at all of the names within the S&P 500 at least, we haven't done this for the broader Russell 3000, I guess. But if you look back at how many names are trading above where they were trading in January of 2022, which was that prior high, the prior bull-market peak, the energy sector was the only one that had every single member trading above where it was in January of that year. So it kind of goes to show that the strength hasn't just been concentrated in a handful of stocks. It's been broad-based. And I will add, too, that if you do look at performance and sector performance since January of '22, the energy sector is still outperforming. So if you were just looking at headlines over the past year and performance over the past year, you would say, "Oh my gosh, it's been a really rough run for energy." But at the same time, if you had a longer time horizon, and you were looking at this on a three or a four-year time, you know, look back, things have looked pretty good for energy. So it is a matter of what you're looking at in terms of the multi-year period or just a one-year period.

LIZ ANN: Let's do broader context here, especially for maybe any new listeners. We always hope that we're getting them. For those that aren't aware, it was a couple of months ago earlier this year that we relaunched something that we've always called Schwab Sector Views. So you've touched, obviously, Kevin, on energy, but it's sort of a two-part question.

Just lay out what the current outperform and underperform ratings are, and then has anything changed in terms of those ratings, particularly through this period of more chop and some underlying weakness over the past few weeks.

KEVIN: Yeah, so the outperforms now are energy, financials, and materials. So definitely more of a cyclical tilt. And I'll explain why in a little bit. And then on the other end of things, the underperforms are, it's just two, its real estate and consumer discretionary. So you know, real estate and, you know, we've discussed this before on the podcast, but for anyone who isn't as aware, real estate, it's probably not as much of a surprise why we have, you know, an underperform just given all of the stress in the commercial sector, kind of the slower burn or the slower fallout over time that we expect for the office space. Not that we think it's at some sort of imminent end and it's going to implode, but you know there are office buildings that either have to kind of rediscover themselves and reconfigure, or they'll just take longer to be filled, and, you know, that sort of represents a little bit of a painful process over time. 

And then for consumer discretionary, it is this mix of you do have a lot of top heaviness kind of working in the in the wrong direction in the case of the second largest stock in that sector being Tesla, and you know we don't cover individual stocks, but it's covered enough and you sort of look at the price action, and you can see that it's weighed a lot on that sector. If you take that out, it has looked a little bit better because you do have the offsetting strength from, you know, the largest member, which is Amazon, but even if you do go sort of down the cap spectrum in that sector itself, within the S&P 500 sector version of the sector, there's still some weakness there developing because of some consumer exhaustion, maybe some softening in parts of the labor market that have a more direct tie to the discretionary parts of the economy. Nothing sinister, but it's just been enough to sort of weigh on that sector, especially relative to the others. I mean, the reason for the, you know, back to the outperforms, you know, it's a mix, and for anyone who's more interested, you can go online and just search "Sector Views for Schwab," and it'll bring you to the latest that we have as an update. We update it monthly. You know, there's a lot of factors that we look at to rate these. It's not just us kind of sitting in a room and saying, "What do we feel good about?"

We actually use a quantitative model that was developed by our friends in the Schwab Equity Ratings department, and they came up with these factors like value and growth and quality, sentiment, earning stability, and we use those to score how the sectors look. So for something like energy, even though it might not score as well on something like earning stability because of the base effects just haven't been as favorable over the past year, there's still relatively strong fundamentals in that sector for things like a high interest coverage ratio, which as regular listeners would know, that's a factor that you and I have been focused on a lot because of rates being relatively sticky here. So that's just a little bit of a flavor to show the outperforms and the underperforms. And to answer your second question, in a shorter way, none of them have changed. So since we launched the model a couple of months ago, and even after everything that's happened over the past couple of weeks, we've kept the ratings the same.

LIZ ANN: Let me stay on factors. We have been focused on factor-based investing for quite some time, well in advance of the relaunch of Sector Views. And so just give us an update on the, at the factor level, what is performing well, might have kind of dragged down performance, both in terms of year-to-date, which is always in focus, but since this recent period of volatility over the last few weeks.

KEVIN: Yeah, well, I was actually just looking at this since the market's most recent peak, which was not long ago. It was March 28th. So we've rolled over a bit from there. But I wanted to kind of take a look since this has been such a momentum-driven market. The momentum factor has been so strong and powering everything, not just year-to-date, but since the recent low last October on October 27th. But there has been a flight to safety, not in a traditional sector sense, over the past few weeks. So companies with the strongest margins, companies with the highest profit growth on a trailing and a forward-looking basis, companies that have strong sales revisions. It kind of runs the gamut. Anything you can think of in terms of a better and a higher-quality metric, that is what's been doing really well. 

And then vice versa, what's been underperforming is maybe no surprise, but things that are maybe a little bit more tied to momentum and volatility. So companies that have the most sort of volatile moves on a day-to-day basis, which you know works well on the upside, but unfortunately doesn't, you know, maybe works equally as unwell on the downside. But that's been the split that we've seen, and that's for the most part been what has been doing well this year. It depends on, you know, which sector you're looking at in particular, but if you were to kind of aggregate it, it has been a higher quality trade that has outperformed and been more consistent.

LIZ ANN: I'm glad you got down to that granular level because I think this is important to put this momentum-driven market in contrast to momentum as a factor being dominant in performance in the late 1990s up to the peak in early 2000. And I've been getting a lot of questions recently about whether that should be a sign that we are in a bubble-type environment like the late 1990s. And I think the really important difference is what you just brought up, which is momentum is a factor. Yes, it's on anybody's factor list, but it's really more of a concept. It's the stocks that have been doing well continue to do well. It doesn't necessarily say anything about the other fundamentals that are embedded in the stocks that are doing well. And the way to illustrate that is the fundamental factor that was most positively correlated with momentum in 1999 and into the peak in 2000 was negative earnings. So it was the lower quality, absent fundamentals, arguably, that is where the momentum was in the late '90s. But as you just pointed out, the momentum has been in stocks that have positive earnings, positive cash flows, positive sales. They're not the crap. They're the higher-quality companies. And I think that's a really important distinction between the current environment. And that doesn't mean we don't have maybe still a richly valued market, but that is, I think, an important distinction relative to the late 1990s.

KEVIN: Oh yeah, and it works in this environment today. It's true within large caps and all the way down to the small-cap indexes. So if you look at something like the Russell 2000 or even the S&P 600, which has more of a profitability filter on it, but it has been the case that the split in performance is very much in keeping with what's profitable and what's not. So the negative earnings factor has been underperforming in S&P 600, in the Russell 2000, and in the S&P 500, of course, but it's been those higher quality metrics that have done well in the large caps this year. And that was not the case in the late '90s. I mean, you look at the run that the small caps had into that peak, it was quite insane. And the IPO activity additionally. So it's in many ways not the same. I don't particularly think any two periods are the same because they never are. Every crisis, every bear market, every expansion is different in my opinion. But yeah, I think it's right to point out that it's not just a large-cap thing today that quality is outperforming.

LIZ ANN: And, you know, a lot of the added pressure recently on small caps has obviously come from the move up in Treasury yields, as we have faced stronger economic data, obviously hotter than expected inflation data. And one of the themes that we have been writing about and speaking about is this notion of the opposite of the normal Fed cycle. So one of the analogies that's used to describe the normal Fed cycle is that they tend to take the escalator up and the elevator down, meaning they generally, in the past, have been more methodical, a little bit slower when raising rates. They understand the deleterious impact it can have on the economy. And when it comes time to cut rates, particularly if they're combating a recession or a financial crisis or some combination thereof, they tend to be more aggressive and they take the elevator down. 

Clearly, at least on the hiking part of the cycle, they took the elevator up with a very aggressive hiking cycle, four 75-basis-point hikes in a row. And now we still assume that the next move will be a cut, but it keeps getting pushed out, and the number of cuts gets pushed down. So as we all go through this process of day-to-day adjusting of expectations around Fed policy, assuming we are in pause mode for a bit longer, the Fed will be less aggressive, less quick to pull the trigger to cut rates. What are the implications at the sector level, at least near term?

KEVIN: So the good news is that, you know, you can look back at prior cycles, and you can kind of get a sense that, yes, in slow cutting cycles, which we'll define maybe as let's say, you know, five cuts or fewer in a 12-month period. So they're not cutting at every meeting. They're not being aggressive. Basically almost the opposite of the past three cutting cycles that we've had. That has tended to, you know, be helpful or more supportive for kind of the broad cyclicals. So you, you lump tech in there, financials, energy, industrials. I like to say it's basically everything excluding healthcare utilities and staples, which are kind of your classic defensive trades or areas of the market that people tend to pile into when you go into a bear market, or if you go into a recession. So that's the good news. I think it's a little bit rougher, harder to say for a universe like small caps because they're so much more reliant maybe on rates coming down for debt reasons and refinancing reasons. But at least within the large-cap universe, you know, a slower cutting cycle, I've kind of been thinking of them as paper cuts as assumed to deep cuts. That would probably be better for, at least as history is consistent with, it would probably be better for kind of that broad, cyclical category.

LIZ ANN: Awesome. Well, Kevin, this has been great. Thanks for giving us an update on a topic that I know our listeners and certainly our investors and our clients are always very keen to hear about. So thanks for joining us.

KEVIN: Yeah, always great to be on. Thanks for having me.

KATHY: I'm happy to be joined now by Collin Martin. Collin is a director and fixed income strategist here at Schwab. He's also a Chartered Financial Analyst, a CFA®, and his focus is on the taxable credit markets. Collin's a frequent guest on Bloomberg TV. He's been quoted widely in financial publications, including The Wall Street Journal, MarketWatch, and Reuters. 

Thanks, Collin, for being here on the podcast.

COLLIN MARTIN: Thanks for having me, Kathy.

KATHY: So today I want to talk about corporate bonds, and that's your area of expertise. So maybe we just get the lay of the land right now. I think the most obvious place to start is, why are spreads so tight? Why is the yield difference between corporate bonds and Treasuries for comparable maturity so narrow?

COLLIN: Well, there's probably a few reasons for that, but I think the most important is that things are going relatively well. If you look at the overall economy, we're seeing a resilient economy that continues to grow and generally outperform expectations. And we're seeing that on the corporate side as well. It's earnings seasons right now, but we tend to look a little backward looking when we look at the corporate bond market, because it's not just S&P 500 earnings that matter. It's all corporate earnings. And when we look at data from the Bureau of Economic Analysis, we recently got fourth-quarter corporate profit data, and it touched another all-time high. So I think as long as companies are making money and seeing that strong growth, it's allowing that to sort of offset the rise in interest expense that a lot of these corporations are having. Because it is true that borrowing costs have risen, but if they're seeing strong profit growth, and if they're seeing strong demand, that's another key factor. Demand for income is high, and that's helping pull spreads down. That's really the key reason because things are going pretty well.

KATHY: Yeah, I think we've contributed to some of that demand too, because despite the tightness and spreads, we still like investment grade, given that all-in yields are attractive, and those fundamentals still look pretty strong. Can you tell us a little bit more about your reasoning behind thinking that this is a good area of opportunity for fixed-income investors?

COLLIN: Well, you hit the nail on the head about valuations versus all-in yields. And I think that's what we want to separate. So we just talked about spreads being low. Spreads, to kind of back up, that that's the compensation that we as investors earn above Treasury yields by investing in corporate bonds. And when spreads are low, that's basically the market saying, "We're willing to accept lower yields because we're not worried as much about a negative outcome or a broad increase in defaults across corporations of all credit ratings," something like that. So valuations are rich. We're not earning much excess or additional spread or yield, but we think those all-in yields are attractive, as you alluded to. If we look at the broad corporate bond market, the index that we look at is the Bloomberg U.S. Corporate Bond Index. The average yield is over 5.5% right now. It fluctuates every day, of course. It's an average of all the issues within that index, but with a yield over 5.5%, we think that's attractive, especially when we look at where we've been over the past 15 or so years. 

These are yields that we know a lot of investors, a lot of our clients at Schwab, have been waiting for. So that's really the key reason, just that absolute yield. But also, one thing that really attracts us to investment-grade corporate bonds, and a key point we make with a lot of our clients, is the slope of that investment-grade corporate-bond yield curve. It is slightly inverted, meaning as you go from, say, one years to three to five years of maturity, you do see slightly lower yields. That's similar to what we see with the Treasury curve, but then it kind of hooks back up again. And if you look out 10 years and beyond, you see corporate-bond yields that are pretty comparable to what you get with short-term corporate-bond yields. And we know something, a big hang up for a lot of investors is that inverted yield curve. And the idea that if you're considering Treasuries, for example, by considering longer-term bonds, like a 10-year Treasury note, you're accepting a lower yield. You're sacrificing yield by going further out on the yield curve. That's generally not the case with investment-grade corporate bonds, so we've been telling our clients to gradually extend duration and lock in some of these higher yields, and we think investment-grade corporate bonds are a good way to do that because if you compare, say, a ten-year average corporate bond yield of more than 5.5%, that's higher than what you can get in short-term Treasury bills. It's higher than what you can get in short-term CDs. And it's generally higher than what you can get with money market funds. Now, of course, it has more risk. There's more credit risk. There's more interest-rate risk. But if the yield hang-up is an issue for investors, that's not as much of an issue. And we still think it's a pretty attractive way to lock in high yields. And as we've discussed, corporations are in good shape. So we're not too concerned about corporate fundamentals with investment-grade issuers.

KATHY: Well, let's talk a little bit more about credit quality, though. So over the years, we've seen a lot more issuance at the lower end of the rating spectrum for investment-grade corporate bonds in those BBBs. Is that still the case, or have things changed recently? Because I think one of the concerns we've had is that you get lower and lower quality on average in the investment-grade universe. It looks like maybe that's changing. Am I right about that?

COLLIN: It is changing, and things have been improving lately. If you look at investment-grade corporate bonds, which is generally what we've been talking about right now, there are a number of credit ratings that make up that investment-grade universe. It starts with AAA, that's the highest rating, then it goes down to AA, single A, and BBB. So those four credit ratings make up the investment-grade credit spectrum. What we were seeing in the years leading up to the pandemic were a rising share of BBB-rated bonds. So that's the lowest rung of investment grade, and just one rung below that is high yield, and that's where things start to get a little dicey. That's where you see defaults generally pick up, historically. So that was a bit concerning where, if you're an investor considering investment-grade corporate bonds, the credit quality on average was deteriorating, and if you're more of a conservative investor, by considering a broad market approach, you may have been taking on more risk than you were expecting.

And if we go back to 2019, that was kind of the peak of that trend, where BBB-rated corporate bonds made up 52% of that Bloomberg U.S. Corporate Bond Index. That's begun to shift, and we've seen the share of BBBs declining over the past few years, and now it makes up just 47% of the index. Now it's still high, of course, it's nearly half, but it shows the improving credit quality that's come from both upgrades, so companies being upgraded from BBB to single A, or just more single A issuers coming to market and making up a greater share there. So I think this is really important, where if we saw the opposite trend, Kathy, if we saw that share of BBBs going from 52% to 55% or 60%, that would be concerning because then it just makes the market riskier. The idea that we've seen the opposite happen, and BBBs, which are those lower rated and

riskier parts of the investment-grade market, that share's been coming down. That's a good thing for investors.

KATHY: Yeah, it certainly is. It's also somewhat reassuring because you do take a step down in terms of credit risk when you go from Treasuries to investment-grade corporate bonds, even though fundamentals are good, there is a difference there. I want to talk quickly about high yield. This is the below-investment-grade. We've been less enthusiastic than we have been about investment grade. What are your thoughts there right now?

COLLIN: We're still a little bit cautious there, Kathy, and I'd say we're less enthusiastic about high yield than we are with investment grade, but I have to acknowledge that the resilient and strong economy that we've seen and the high corporate profits, that is a good thing for all corporate-bond issuers, whether it's investment grade or high yield. What really hangs us up with high yield is that spread that we talked about before. Spreads are very tight in the high-yield space as well. They've been hovering around three percentage points for the past number of weeks. It's not at all-time lows or tights yet, but it's getting relatively close. Our concern with high yield is when spreads get that low, that just provides very little wiggle room in case the outlook deteriorates. Again, it's been very strong lately. The economy is chugging along, but if we take a turn for the worse, you can see high-yield spreads rise a lot and very quickly and a lot more than you'd see with investment-grade corporate bonds. So it's just very little margin for error. So the way we approach high-yield bonds right now, we think investors can still consider them. We highlight that they do come with a lot of risk, of course. We'd highlight that they tend to be more volatile. And we'd suggest, if you are considering high-yield bonds, consider more from a long-term standpoint, because over the short run, if the economy does deteriorate, you'd likely see those prices fall a lot more sharply than you would with investment-grade corporate bonds.

KATHY: And when you see those spreads spike up, I mean, it can be very fast and very big. It can be a very explosive move over the short run. So I think that can shake people up quite a bit, particularly if you're not that kind of investor. One last question, I wanted to ask you a question that I got from a client recently. He was concerned that a lot of the corporate bonds that he looks at are callable, and that bothered him because nobody wants to buy a bond with a nice yield and get it called in. So what are your thoughts there on callable bonds?

COLLIN: Well, there are a lot of callable bonds in the corporate-bond market, so it's not surprising to hear that was a question from one of our clients. There's a few things to consider when we're considering callable bonds. Not all callable bonds are created equally. There's really two types of calls, too. There's traditional call features, and then there's something that's called a make-whole call feature. Let's focus first on the traditional call feature. So a lot of bonds come to market, and they're issued with a standard maturity date, par value, coupon rate, things like that. But they might have a call feature, which allows the issuer to redeem that bond at its par value, so usually $1,000, after a certain period of time has passed. And then that's a risk for investors, because if yields fall, and the issuer might say, "I'm going to retire that bond now. I'm going to call that bond in early," and then reissue a new bond at a lower yield. So it benefits the issuer because they can lower their interest expense, and it's a disadvantage to investors because you might have thought you locked in what you thought was an attractive yield only for it to be called away because the interest rate environment has shifted, bond yields have fallen, and then you're likely facing a lower yield to reinvest those proceeds in. A few caveats though, Kathy, kind of to get to the point you made about a lot of the corporate bond being callable: the amount of call protection varies. So when I think of a traditional callable bond or where the most call risk is, that's with a bond that has a call date in the short run. So think of 12 months or less, because if yields were to fall quickly, you wouldn't really get a benefit of a rising price because bond prices and yields move in opposite directions, and there's a greater likelihood that the issuer would retire that bond early should interest rates fall.

What we've seen lately is companies issuing callable bonds, but with a lot of call protection for us investors, where it might be a 10-year bond that's callable after nine years, which means you have nine years before it's even callable. Companies generally just do that for flexibility purposes, but if you're looking for bonds, if you're a bond investor who searches for individual bonds yourself, that's still going to come up as a callable bond, but those are very different features, and they'll perform very differently given fluctuations in bond yields. And then one last point, Kathy, is the make-whole call. This is a very different type of call than your traditional call. A make-whole call allows the issuer to essentially retire the bond any time it wants, but the price isn't usually that $1,000 par value. It's a market-driven price. So if yields fall, and in the secondary market the price of that bond has risen, the issuer would need to pay that higher price and actually usually at a premium as well to retire that issue. So falling interest rates aren't necessarily a bad thing if there's a make-whole call feature because investors tend to benefit. So make-whole calls, they rarely happen. If you're looking for individual bonds and you see a make-whole call on a certain bond, it's not something that we're usually worried about, and they tend to act just like traditional non-callable bonds in the secondary market where their prices and yields do still tend to move in opposite directions.

KATHY: Yeah, I think a lot of those make-whole calls are when there's a change of control or a sale of a company or something like that. They're not triggered as often as you might think. That's great information. Thank you. So less to fear about the calls, just more to pay attention to them and understand them and understand how that's priced in the market. And great information on the investment-grade side in particular, a little deep dive into how we look at that market. Thanks, Collin.

COLLIN: Thank you for having me. Always happy to talk corporate bonds.

LIZ ANN: So Kathy, we're past tax season, which we're all happy about, not about tax season, being past tax season. And it'll be summer before you know it. So what is on your radar for the next week?

KATHY: Well, really keeping an eye on the various readings from the regional Fed banks, and we'll get some of them next week. We'll also get the core PCE, which is obviously very important because that's the metric that the Fed uses for inflation. So obviously, a lot of focus will be on that. But I think when it comes to long-term policy outlook, it's really important to see what's coming out of the various Fed districts. So they talk frequently to employers, to workers, to students. They're out in the public a lot, kind of taking the temperature of what's going on in the economy regionally. And I think that is increasingly important when setting Fed policy, what they're hearing sort of on the ground, because it's more timely than on many of the readings that we get with the aggregated data. So we're going to be keeping a really close eye on that. How about you, Liz Ann, what's on your radar?

LIZ ANN: Yeah, I agree. I often find the regional Fed data interesting, particularly some of the details. We also get the S&P Global version of the PMIs. And unlike ISM, which ISM is watched a little bit more, you get the manufacturing and the services and composite all reporting on the same day. So that is interesting. You've got GDP data coming out.

The trade balance doesn't tend to be much of a market mover these days, but sometimes can have some interesting tidbits. And then some housing-related stuff. You've got new home sales and pending home sales. And then the University of Michigan sentiment data, which also has inflation expectations, which sometimes can be interesting. So that's what's on my radar.

KATHY: Thanks for listening. That's it for us this week, but you can always follow us on social media. I'm @KathyJones, that's Kathy with a K, on X, formerly known as Twitter, and on LinkedIn.

LIZ ANN: And I'm @LizAnnSonders on X and LinkedIn. By the way, I'm only active on X and LinkedIn, and I've had a lot of imposters on X, or Twitter. In fact, I think it was, as we're taping this yesterday, I posted just a screenshot of the current round of imposters, but also wanted to just let this audience know I am not active on Instagram. I'm not active on Facebook. I'm not active on WhatsApp.

And there are a lot of scammers out there that are using my likeness, and they're pitching investment clubs and stock-picking clubs. Anything you see that looks like it's me on any of those platforms, I promise you it is not me. So just a public service announcement. 

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Next week, I will be joined by Sebastien Page, head of global multi-asset and chief investment officer at T. Rowe Price. So, you won't want to miss that. He is really interesting to listen to, so tune in.

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