Charles Schwab Guest Market Perspective: Crossroads

July 29, 2022

Amid signs of slowing growth, the economy has reached a crossroads on key issues: Will we see a recession or a soft landing? Will Russia's scheduled "maintenance" shutdowns of a key natural gas pipeline endure long enough to hurt Europe's economy? Will longer-term Treasury bond yields be more affected by inflation or by slowing economic growth?

We don't know when we'll have the answers, but some clarity may emerge later this month. Second-quarter earnings season begins soon, potentially providing clues about the strength of the economy and how well companies are positioned to deal with it. July developments around the Nord Stream pipeline may tell us more about Europe's access to natural gas later this year. And while another interest rate increase is expected at the Federal Reserve's July 26-27 meeting, markets are looking forward to hearing what Fed Chair Jerome Powell has to say about the economy at his post-meeting news conference.  

U.S. stocks and economy: Moments of truth

Is a recession coming? Economic bulls and bears are debating whether the data point to slower but continued growth (a "soft landing," to use the Federal Reserve's terminology), or a recession. 

The state of the job market is a battleground in this debate. The bulls cheered the June U.S. employment report. The economy added 372,000 jobs and the unemployment rate was at a low and steady 3.6%.  

However, the picture changes if you look at the leading job market indicators, which historically have previewed coming economic trends. For example, at turning points in the economic cycle, the monthly employment report’s "household survey"—which includes agricultural, self-employed, and private household workers that aren’t included in the main employment data—tends to be increasingly important. 

As you can see in the chart below, the household survey has fallen much more sharply than the still-strong nonfarm payroll survey over the past three months. The drop in the leading measure doesn't necessarily prove that payrolls are peaking, but if they are, it would be consistent with prior instances in which the household survey previewed overall weakness.

Diverging payrolls

Source: Charles Schwab, Bureau of Labor Statistics, as of 6/30/2022. Y-axis is truncated at 3,000 and -3,000 to account for pandemic-related distortions.

Other leading job market indicators, such as weekly initial jobless claims and layoff announcements, also suggest the job market is softening. Meanwhile, consumer and business confidence are suffering in the face of tighter monetary policy, faster inflation, and slower growth, reflecting the weakness in financial markets and the outlook for corporate profit margins. Because labor is often the largest cost for companies, creating more new jobs could prove challenging. 

At the same time, stock prices and corporate profits have become more correlated in recent years. That doesn't necessarily mean a drop in share prices automatically portends lower profits, but it's worth watching the relationship. 

Better (or worse) together

Source: Charles Schwab, Bloomberg, as of 6/30/2022.

Note: Correlation is a statistical measure of how two investments historically have moved in relation to each other, and ranges from -1 to +1. A correlation of 1 indicates a perfect positive correlation, while a correlation of -1 indicates a perfect negative correlation. A correlation of zero means the assets are not correlated.  Past performance is no guarantee of future results.

Company fundamentals are always critical, and the coming corporate earnings season is likely to provide some moments of truth for the market. Hopefully, managers' economic outlooks and forward earnings guidance will provide a clear sense of how well companies are positioned in this challenging economic environment. 

One measure to watch for signs of weakening will be forward estimated operating margins. As you can see in the chart below, margins are off their recent highs but have largely trended sideways this year. A significant decline in margins would be consistent with prior market selloffs. Should that occur this year, we think it may be the catalyst for stocks' next move lower. 

Operating margins on edge

Source: Charles Schwab, Bloomberg, as of 7/8/2022.  Past performance is no guarantee of future results.

  Global stocks and economy: Europe's big risk

Although Russia's invasion of Ukraine didn't immediately stifle European economic activity, the threat of a cutoff of Russian energy supplies to Europe remains an important economic risk. Europe's inventories of natural gas had been building at a typical pace for this time of year, after dropping to very low levels this past winter. As of July 9, storage was 62% full and on track to achieve a target of 90% by November, when winter heating demand typically begins.

Natural gas inventory had rebounded to average for this time of year

Source: Charles Schwab, Bloomberg data as of 7/11/2022.

On June 14, Russia's Gazprom cut natural gas delivery to Europe via Nord Stream, a pipeline running under the Baltic Sea, by 60%. This was purportedly to allow for maintenance work, to be followed by a scheduled interruption of supplies for 10 days starting July 11. 

Officials in Germany, the country most dependent upon these flows, have expressed concern that gas deliveries may not return to normal levels after these interruptions, or that they might not return at all. In response to Gazprom's declaration, the German government raised the risk level in its national gas emergency plan to the second highest "alarm" phase, signaling disruptions but continued supply. They also announced the restarting of coal-fired power plants to conserve natural gas. Initiatives to ration energy, which would have considerable economic consequences, have yet to be announced. Direct restrictions on the use of natural gas kick in at the third and highest alarm level. Severe supply disruptions would have broad implications across Europe as Germany is an important gas hub for Europe, re-exporting on average more than 40% of its imports to neighboring countries.

If supply cuts are sustained, or worsened, and alternative sources can’t make up the gap, some rationing of gas may be necessary to reach the 90% storage target by November 1 and avoid a winter heating crisis. Additionally, because about 15% of German power is generated by natural gas (based on 2021 figures) and 40% of that supply typically comes from Russia, there is risk to about 6% of total electrical power generation.

Germany's power production by source

Source: Charles Schwab, Macrobond, Arbeitsgemeinschaft Energiebilanzen e.V. as of 6/29/2022.

If Nord Stream gas flows resume at a normal pace, the 90% target could be reached by reactivating some coal power plants and increasing imports of liquified natural gas from other nations. Rationing could be avoided.

If Nord Stream gas flows resume at only 40%, some economic impact may be felt. Germany's economy minister has said that any energy cuts would be targeted first at businesses rather than consumers. These might be direct users of natural gas such as the chemical and metal industries, which could slow economic output and potentially create supply-chain drags. Alternatively, reducing gas-powered electricity production by 2%-3% of total power generation and diverting those supplies to storage to reach the November target may be necessary. This has potential negative impacts to output for the large German automotive, mechanical, and electrical manufacturers reliant on a stable electricity supply.

In the worst-case scenario, if Nord Stream gas flows permanently cease in July, natural gas storage targets may not be achievable before winter. Deeper cuts totaling 6% of total electricity production might be needed to avoid a heating crisis, with greater impacts to industry and households. The German government would likely seek to lower demand by allowing natural gas prices to rise sharply, risking rising inflation and a recession. We will be monitoring Europe's access to natural gas closely as the July developments unfold.

  Fixed income: Caught in the middle

Bond yields are caught between the prospects for inflation and recession. After surging to nearly 3.5% in mid-June when the Consumer Price Index (CPI) hit a 40-year high of 8.6%, 10-year Treasury yields have been trading in a volatile range around the 3% level. We expect the volatility to continue for the next few months. However, we believe that the impact of slowing growth and/or recession risk likely will drive long term yields, outweighing inflation concerns in the second half of the year. 

With the Federal Reserve focused squarely on bringing down inflation, more rate hikes are likely in the second half of the year. We expect a 75-basis-point  increase in the target range for the federal funds rate in July, and another 50-basis-point hike in September. At that point, the upper bound of the federal funds rate would be 3%, above the Fed's estimated neutral rate (that is, where policy is neither so easy that it risks inflation, nor so tight that it risks slower growth). 

Because inflation is running far above the Fed's 2% target, it would make sense to move rates above neutral to get to a more "restrictive" policy. What we don't know yet is how restrictive policy will be. It's worth remembering that in addition to rate hikes, the Fed is also tightening policy by allowing its balance sheet to shrink. In other words, Treasury securities held by the Fed are being allowed to mature without the Fed reinvesting the proceeds (a strategy called quantitative tightening, or QT). Using QT should mean that the peak in the federal funds rate is lower than it would be if the Fed were relying on rate hikes alone to cool inflation.

The Fed's aggressive tightening risks tipping the economy into recession. Gross domestic product (GDP) growth was negative in the first quarter, and likely weak in the second quarter. Leading indicators of growth, such as housing activity, new business orders, and consumer spending all have turned lower in the past few months. Global growth is also slowing due to the impact on Europe of the Russia-Ukraine war, and China's stop-and-start COVID restrictions. Leading indicators suggest much slower growth in the world's major economies over the next six to 12 months.

OECD leading indicators for major economies

Source: Organisation for Economic Co-operation and Development (OECD), as of June 2022.

Note: The OECD's work is based on continued monitoring of events in member countries as well as outside OECD area and includes regular projections of short and medium-term economic developments. Y-axis truncated at 95 for scaling purposes. For reference, 2020 low for the United States is 92.3, OECD - Europe is 89.0, and China is 82.9.

Market-based readings on inflation expectations indicate more concern about growth prospects than about ongoing high inflation. Five and 10-year inflation expectations embedded in the Treasury Inflation-Protected Securities (TIPS) market have retreated to the 2.5% level. 

TIPS breakeven levels are signaling lower long-term inflation expectations

Source: Bloomberg.
U.S. Breakeven 10 Year (USGGBE10 Index) and U.S. Breakeven 5 Year (USGGBE05 Index). Daily data as of 7/13/2022 The breakeven rate is the difference between the TIPS rate and the comparable-maturity Treasury rate and is used as a gauge for what market participants believe inflation will be five or 10 years in the future.

The outcome of running a tight monetary policy in a slowing-growth environment is likely to be further flattening or inversion of the yield curve, underperformance of riskier segments of the bond market and a stronger dollar. The yield spread between two- and 10-year Treasuries is already inverted, which in the past has been a signal of a potential recession.  

The spread between 2- and 10-year Treasuries has narrowed

Source: Bloomberg. 
U.S. Generic 10-year Treasury Yield (USGG10YR INDEX). Daily data as of 7/13/2022.

Riskier segments of the bond market likely will struggle relative to Treasuries in the second half of the year. In the corporate bond market, yields on sub-investment-grade, or high-yield, bonds have been rising faster than Treasury yields. These bonds tend to be more sensitive to economic growth, with a higher risk of default in a rising-rate/slowing-growth environment. 

Emerging-market bonds are underperforming Treasuries and developed-market bonds due to the combination of slowing global growth and a strong U.S. dollar. Many of the issuers have high amounts of dollar-denominated debt that is now more difficult to service, with their currencies declining versus the dollar. We see the dollar continuing to stay strong until there is more confidence that the Fed's rate hikes have reached peak levels.

The U.S. dollar has strengthened 

Source: Bloomberg.
Bloomberg Dollar Spot Index (BBDXY Index). Daily data as of 7/13/2022.  Past performance is no guarantee of future results.

As the tug-of-war between inflation and recession fears plays out in the second half of the year, we expect to see continued high volatility in the bond market, but also believe there is a good chance that the cyclical high in intermediate to long-term yields may have been reached. We suggest investors focus on staying in higher-rated bonds and gradually add duration  to portfolios in anticipation of lower yields by year-end.

 

 

Market Update: Inflation, AI, and the Road Ahead

June 25, 2026
Markets continue to navigate a mix of encouraging economic news and ongoing global uncertainty. While investors remain optimistic about the long-term outlook for the economy and corporate earnings, headlines from around the world continue to influence day-to-day trading. One of the biggest factors remains geopolitics. Although tensions in the Middle East have eased somewhat, investors are still watching developments closely because they can affect oil prices, inflation, and ultimately interest rates. Lower oil prices this week have helped calm some inflation concerns, which has been a positive for the broader market. Technology also remains in the spotlight. Strong earnings and continued investment in artificial intelligence have supported parts of the market, although investors are becoming more selective as valuations in some technology companies remain elevated. Looking ahead, markets will continue to focus on inflation data and the Federal Reserve's next steps. If inflation continues to moderate, it could provide support for stocks. However, unexpected developments overseas, changes in energy prices, or shifts in economic data could still create short-term volatility. While short-term market movements can be unsettling, they are a normal part of investing. Rather than reacting to daily headlines, we remain focused on building portfolios designed to weather changing market conditions and help you pursue your long-term financial objectives. Maintaining a disciplined, diversified investment strategy remains one of the most effective ways to navigate uncertainty. As always, if your financial situation or goals have changed, we're here to help ensure your plan continues to align with what matters most to you.

What We're Watching This June — Market Thoughts for You

June 1, 2026
As we turn the page to June, markets find themselves at a familiar crossroads: optimism tempered by uncertainty, momentum tested by macro headwinds. May closed on a constructive note, with equities finishing the month at or near all-time highs — a remarkable recovery from the turbulence that defined the early part of the year. The dominant theme of 2026 has been resilience in the face of disruption. From the tariff volatility of the first quarter to geopolitical shocks in the Middle East, investors have repeatedly demonstrated a willingness to look through near-term noise toward the fundamentals. That posture has been rewarded. The S&P 500 has returned over 10% year-to-date, driven in large part by an exceptional earnings season — first-quarter blended growth came in above 28%, the strongest pace in several years — and continued enthusiasm around artificial intelligence investment. Yet the risk landscape heading into summer is far from benign. The conflict in the Middle East remains the single most important variable in the macro calculus. Energy markets have been severely disrupted, with Brent crude up sharply on the year despite recent relief as hopes for a resolution in the Strait of Hormuz gained traction. Oil prices are not merely an energy story — they are a consumer story, an inflation story, and ultimately an interest rate story. A durable peace agreement could be a meaningful tailwind; a breakdown in talks, the opposite. The bond market deserves particular attention. One of the defining features of this cycle has been the breakdown of the traditional stock-bond diversification relationship. Since the onset of the Middle East conflict, long-duration Treasuries have failed to provide the ballast they historically offered during periods of equity stress. Sticky inflation, persistent fiscal deficits, and energy-driven price pressures have conspired to keep yields elevated. Investors relying on a classic 60/40 framework may find that the playbook requires updating looking into high quality corporates. On the monetary policy front, the transition at the Federal Reserve — from Chair Powell to Kevin Warsh — has so far been absorbed calmly, with equity and bond volatility both declining in recent sessions. The Fed's path remains data-dependent, and this week's jobs report will be closely watched. Consensus expects the unemployment rate to hold near 4.3%, consistent with a "low hire, low fire" labor market. More interesting may be the wage data: softening wage growth could constrain consumer spending at a moment when the personal savings rate is already under pressure. Globally, the picture is more nuanced than a simple risk-on or risk-off framing suggests. European equities outperformed in May, while the ECB is now actively signaling the possibility of rate hikes in June — a stark contrast to the easing cycle many had anticipated a year ago. Emerging markets have staged a meaningful recovery, supported by AI infrastructure spending and a softer U.S. dollar. The macro divergences between regions are as wide as they have been in years, and that creates both risk and opportunity depending on how portfolios are positioned. Seasonality is worth noting as well. June has historically been a challenging month for equities in midterm election years, and after a sharp rally off the March lows, some degree of consolidation would not be surprising. Markets rarely move in straight lines, and the conditions for short-term choppiness — elevated geopolitical risk, a pivotal central bank meeting in Europe, key economic data releases, and a VIX that has returned to complacency — are present. The bottom line: the fundamental backdrop remains broadly supportive, earnings momentum is intact, and long-term investors have been well-served by staying disciplined. But the risks are real and the range of outcomes is wide. In an environment where traditional hedges are less reliable and geopolitics can move markets overnight, diversification, quality, and a clear-eyed view of one's own time horizon matter more than ever. As always, we are here to discuss how these dynamics relate to your specific situation. Please do not hesitate to reach out.

The Order of Returns

April 29, 2026
The first four months of 2026 have been a useful reminder that markets do not move in straight lines. After entering the year at record highs, U.S. equities pulled back sharply on geopolitical tensions tied to the Iran conflict, with the S&P 500 coming close to a ten percent decline before recovering much of that ground. Volatility has returned again on rising energy prices and a softer tone from the technology sector that has carried so much of this cycle’s leadership. Oil sits near one hundred dollars per barrel, the ten-year Treasury yield hovers near four and a half percent, and traditional diversification between stocks and bonds has been less reliable than many investors have come to expect. None of this changes our long-term view. It does sharpen a conversation we believe every household within ten years of retirement, on either side of that line, should be having right now. THE QUESTION THAT MATTERS MOST After more than thirty years of advising families through every kind of market, I have come to believe that one question matters more than almost any other in retirement planning. It is not what your average return will be. It is not even how much you have saved. The question is this: in what order will those returns arrive, and what will the portfolio be doing when they do? Two households can finish their working years with identical balances and identical long-term average returns. One can run out of money. One can remain wealthy for life. The only difference between them is the order in which good and bad years happened to fall. WHY ORDER MATTERS MORE THAN AVERAGE When a portfolio is accumulating, a market drop is something close to a gift. Contributions buy more shares at lower prices. When a portfolio is distributing, the same drop is a wound. Every dollar withdrawn during a downturn cannot participate in the recovery, and the base from which all future growth compounds is permanently smaller. Retirees who began withdrawals in 1973, in 2000, or in 2008 lived through outcomes quite different from those who retired even two or three years earlier or later. Same averages over the long arc. Very different lives for the family. THE RETIREMENT RED ZONE Retirement planning does not begin the year you stop working. It begins five to ten years before. We sometimes call that window the retirement red zone, and it is the period in which the wrong portfolio, held too long, can do real and lasting damage. A portfolio that served someone beautifully through their fifties is rarely the right portfolio for the first decade of withdrawals. Waiting until the retirement date itself to reposition is not a plan. It is a hope. HOW WE REPOSITION PORTFOLIOS Repositioning is a multi-year process, not a single trade. We model honest cash-flow needs in dollars. We construct one to three years of withdrawals in stable, liquid reserves so no client is ever forced to sell equities into a falling market. We build an intermediate layer of high-quality bonds to refill those reserves over time. We sequence withdrawals across taxable, traditional, and Roth accounts to manage lifetime tax cost, often using the years before Social Security and required minimum distributions for thoughtful Roth conversions. We rightsized concentrated and legacy positions over multiple tax years. And we stress test the plan against a meaningful market drop in year one before any client crosses the retirement line. A CLOSING THOUGHT Sequence risk is not really a math problem. It is a human one. The discipline to reposition during good markets, when it can feel almost unnecessary, is what separates retirees who sleep well from those who reach for the wrong decision at the worst possible moment. By the time a dramatic market drop arrives, the work either has been done or it has not. Whether you are a long-time client of Affinity Capital or considering a relationship with our firm, we would welcome a conversation about how your portfolio is positioned for the years ahead.