What Lies Beneath (your stock or bond index) with Liz Ann Sonders

Please stay tuned after the conclusion of the podcast for additional important information.

Greg Hall: Hey, everybody, welcome to another episode of Accrued Interest, PIMCO's podcast dedicated to serving financial advisors, their clients, and the wealth community at large. I'm really excited for today's episode. We have Liz Ann Sonders at Charles Schwab. I think many of you know Liz Ann, know the name, have followed her over the years. Liz Ann is the chief investment strategist at Charles Schwab.

She and her partner in crime, Collin Martin, who's the head of fixed income strategy at Schwab, host the On Investing podcast, of which I'm a huge fan and frequent listener. One of the inspirations for—one of the many inspirations for Accrued Interest. I think every time I have a podcast guest on the show here, I thank them for their contribution to helping us think about Accrued Interest.

So, Liz Ann, thank you for that. And you probably see her all over the news media as well. She's frequently in the Wall Street Journal, New York Times, Barron's and the FT. I think that you, Liz Ann, have been named one of the 100 most influential women in finance every year that that particular award has been granted.

Liz Ann Sonders: Yes, the Barron's list. So thank you.

Greg Hall: No, no, it's amazing to have you here, and I'm so glad you could find the time to join us.

Liz Ann Sonders: My pleasure.

Greg Hall: We were talking before the show a little bit, just how much I think, you know, I appreciate what you do on On Investing. I love the format that you all choose. You start with your market recap, get everybody level set, and then you dive into a really interesting topic. I will confess, huge fan of you and Kathy doing it together.

Until earlier this year, I was nervous about a new co-host on my favorite podcast. But I will say that Collin has more than acquitted himself, and he's done a tremendous job, and it's every bit as enjoyable to listen.

Liz Ann Sonders: Oh, thank you. Thank you. Yeah, no, we miss Kathy for sure. I had a long phone conversation with her. She's in retirement now and enjoying herself, and I almost wish the recording had been on so that we could, you know, drop an episode of just Kathy and I chatting on the phone, me still working and her retired.

Greg Hall: Well, I suppose retirement is why we all, you know, are engaged in this activity, right?

Is helping me to get to retirement, right? So, yeah. So we can hardly begrudge her, you know, enjoying the fruits of her labor.

Liz Ann Sonders: Yeah.

Greg Hall: One of the things I love about the way you approach the podcast and your research publishing generally is you don't dumb it down. And I'd love your viewpoint on this, but I think oftentimes there can be a little bit of a snooty assumption that when speaking to the wealth audience, you've got to take complex concepts and make them really simple.

And I've met so many financial advisors in my position. Not one of them has been incapable of understanding complex financial concepts. In fact, many of them much more familiar with it than I am and have a lot of scars to prove it. But you do make it pragmatic, and you discuss implications and what to do about things.

I think that, you know, making it efficient, making it useful is really the secret to making it work for our audience.

Liz Ann Sonders: Well, thank you. And, you know, I certainly don't try to dumb it down, but I do try to make it digestible for a wide array of levels of sophistication in terms of the client base. And what's interesting is, more often than not, if somebody is kind enough to send me an email or got me on the street or in an airport to say thank you for writing in a way or speaking in a way that the majority of people can understand, more often than not, it's people on the more sophisticated end of the spectrum, not the mom-and-pop investor. It is a fine line. I try to draw that line as straight as I can.

Greg Hall: Yeah. Do you—you know, just kind of given the platform on which you sit and its sort of long-standing commitment to the individual investor in this country—do you construct your research or the podcast with the end investor in mind, or do you think a little bit more about the advisor that sits in between?

Liz Ann Sonders: Both. You know, it's about evenly divided between what we call investor services, which generically is our retail clients, and the advisors that sit on our platform, so our advisor services business, exclusive of the other parts of our business, which is the asset management side, the bank and workplace services. And so I keep both audiences in mind. Ultimately, the advisors that work for us, for the most part, are managing money for individual investors.

So even through that funnel, the ultimate audience are individual investors. And I think the research provided, the way you go about it, what is more—what's most important does, frankly, differ a bit from a traditional institutional audience. And, you know, our sort of motto, our tagline, whatever you want to call it, of "Through Clients' Eyes," it absolutely is paramount every time I open my mouth or put proverbial pen to paper.

Greg Hall: Yeah. No, that's such a good point. We—you know, really mundane things like taxes completely change the way that you would think about it for an individual, two-legged investor versus, say, a tax-exempt institution.

Liz Ann Sonders: Absolutely.

Greg Hall: And just making sure that that's kind of part of the dialogue. Well, today, I think, you know, we wanted to talk about a phenomenon that you've been spending a lot of time on.

You've been writing about, you've been talking about, and this is probably a good stretch of time. So we're recording this on the 22nd of October. And, you know, what would you say—we're about a week or two into a little bit of, shall we say, testing of the bull market AI hypothesis?

Liz Ann Sonders: Yes, no question about it.

Greg Hall: So maybe we can talk a little bit about that and what you're seeing in trading patterns right now and maybe your own kind of fundamental views. But then we want to talk about the status of our indices, you know, what we look for as benchmarks, and just, you know, how the excitement and the burgeoning valuations in technology and AI have reshaped indices and what that means for advisors and their clients.

Liz Ann Sonders: Sure. So, you know, the always most popular index, just in terms of how we think of it as tracking the market, but also the most widely used benchmark, of course, is the cap-weighted S&P 500. And increasingly, it's a stealth AI bet, given that the 10 largest names represent about 40% of the index, and most of them are tied into the AI theme. The technology sector, 38% of the overall S&P.

And then you tack onto that if you bring in communication services, which houses Google and Meta, and then you bring in consumer discretionary, which houses Tesla and Amazon, and you're talking about a massive weight. It's certainly less so at the equal-weighted level, but on a cap-weighted level. And we've gotten to the point where the contribution from a capitalization standpoint is larger than the earnings contribution.

That isn't necessarily some imminent risk, but that spread is something to be at least mindful of. And that said, I really do worry about the earnings concentration right now. The consensus for calendar year 2026 earnings, so beyond the third quarter that's being reported right now, is about 35% year-over-year growth. That's for the S&P 500. But 35% or so of that growth is just two stocks.

It's Nvidia and Micron. And if you go out to the 10 largest earners, which are not all tech or related stocks—you get the big oil companies in that mix too, Chevron and Exxon—but it's close to 70% of earnings growth. So as breadth has been improving a little bit in the last week or two, maybe near-term less concern about market cap–related concentration, but it absolutely still exists in terms of the earnings outlook.

Greg Hall: Yeah, we had Dan Ivascyn, our CIO, on just about this time last week, and we started down sort of a similar path of just talking about the optimism embedded in macroeconomic projections, as well as in the stock market, about whether or not the AI investment cycle can truly produce the ratcheting up of earnings expectations.

Do you have—I can understand your concern about the implicit concentrations. Do you have kind of fundamental fears about that? Are you looking at anything right now that suggests to you that, as opposed to it being sort of statistically improbable, it's actually fundamentally unlikely to unfold that way?

Liz Ann Sonders: Well, I'm paid to both look for opportunities and assess risk. And I think the very elevated expectations bar, whether it's a function of the sell-side consensus published estimate, but at times the much higher bar set by the buy side in terms of their expectations—that, of course, is unpublished. And that's where you're starting to see some interesting action on the part of stocks that might beat the published numbers, even if it's both on the top line and bottom line, but seemingly come short of that buy-side loftier expectation. But I think the weakness that is showing up is more individual to each stock. I'm not worried about some aggregate problem at this point. I think we have to be mindful of the market as a leading indicator, tending to sniff out the inflection points, whether it's in CapEx assumptions, whether it's in earnings assumptions, that second derivative.

I'm—you know, 40 years I've been doing this, and I'm always fond of saying that better or worse typically matters more than good or bad when it comes to things like the relationship between the trajectory of earnings and when you hit that inflection point. The good news is, because the E has grown so much faster than the P, we've taken more than four multiple points out of the S&P forward P/E over the past year.

That is almost necessary because we're now in this higher-for-longer yield environment, which, all else equal, puts downward pressure on multiples. But we fortunately got that courtesy of the E growing faster than the P. I'm not worried about near-term earnings assumptions having gotten too pie-in-the-sky, but I do think that we're at a little bit of a trickier point, and there's going to be more of a discerning eye on sort of who's still got it and who doesn't, who's still spending, who can't afford to spend anymore, what the monetization story is, what the access to capital, what the cost of capital is.

So we're getting a little bit more granular now, as opposed to AI is the biggest boom in the world, and the CapEx numbers are through the roof, and rah-rah, you know, buy any version of a cohort that's a play on that. I think that ship has largely sailed.

Greg Hall: Yeah. We talk about it as the sorting function, maybe having begun. You move from phase one of ebullience into, not—certainly not despair, but more just, now we're going to pick winners. And then, of course, in the debt markets, for us, without access to some of the equity upside, I think what Dan would say is we always have to be selective because, you know, the most we're going to get back is par plus, you know, our coupons. And so we can't afford to let optimism carry us away into credit decisions.

Liz Ann Sonders: You know, the other thing on that—and I'm sure we'll talk about it in a little more detail—but, you know, the interesting thing now is the simple approach to diversification by having fixed income in your portfolio in addition to equities. You've got to be mindful of that AI concentration over on the fixed income side too, given that, I think, you know, early on, the hyperscalers represented, I think, about 2% of supply, even maybe a year ago.

And now it's like 11 or 12% of supply. So you also have to be careful that you're not carrying that exposure both in the equity side of your portfolio and the fixed income side of your portfolio. So I think it requires more careful diversification right now.

Greg Hall: Yeah, that's a huge theme for us. I'm really glad you brought it up. And we can talk about it now. We'll talk about it later. We'll probably talk about it a few times. But you're absolutely right, the impact on the indices just in terms of raw supply. But then when you factor in that some of these, the hyperscalers or the structures they're using, tend to be longer duration, right, when they have spread deterioration, then their contribution to the risk in the index increases because they've got higher spreads, longer duration. So that has become a palpable change to benchmark exposures. And then the supply that doesn't come into the index, of course, you know, like the 144A transactions and things like that, that has an impact on aggregate demand for those issuers.

So that does affect the index, even if the actual issuance isn't in the indices themselves. It will not surprise you that we, as an active manager, think that's a terrific opportunity for us to differentiate ourselves relative to the passive benchmarks, but it's certainly something that we're paying attention to every day.

Liz Ann Sonders: The other thing that's interesting is you talked about duration, and one of the other spotlights that I think has been turned a little bit brighter on this whole AI narrative and story is concerns about leverage, obviously, as cash flows come down and there's more need to debt-finance this build-out. But inherently with leverage, it means you are financing the timeline.

And a lot of these companies and projects are longer duration. But as we know, the half-life of narrative changes, the speed with which adoption is happening, disruption is happening, has just gotten so, so compressed. So the other thing I think we have to be mindful of is, is there sort of, generically stated, a duration mismatch in terms of long-duration equities or the duration of the leverage, and how fast things can turn on a dime in terms of companies' prospects, industries' prospects, even, you know, what's the shiny new object this week or this month?

Greg Hall: Yeah, I mean, it's—you know, you don't want—I don't want to sound like the wet blanket at the party. But I think, again, this is the reason. I mean, we published this in our Secular Forum piece, which is this thing we do once a year where we try to take a look. It's not the next quarter, it's not even the next year, it's the next five years.

And we just think about broad, broad secular themes that are going to define investing. It's more fixed income oriented. But we highlighted selectivity around these credits as just being paramount for exactly the reason you've stated. If the issuer's priorities change and the structure doesn't protect you as the lender to the project or what have you, then in essence, you're buying the hype, not the credit.

And again, it's, you know, we don't have the luxury of necessarily making, you know, a hundred times our money, like you may think you have in an equity investment. So it just requires, like, much more discipline around those decisions. And we've done a number of—you know, we've been in the headlines with a number of prominent deals, but I think the number of ones that we've walked away from or passed on, you know, outweigh that by multiples.

Liz Ann Sonders: Well, let me pull on the thread of what you said with regard to buying the hype. I think another—this is a much broader issue that I think comes into play in your world on the fixed income side, in my world on the equity side—is this blurring of the lines that has become more acute in the last few years between investing and gambling: short-termism, the rise of the retail trader, the power in terms of day-to-day action in the market in the hands of systematic funds or the long-short hedge fund community, the commodity trading advisors. And they're playing a short-term game off of each other's positioning, where a trade's crowded, where a trade's less crowded. So there's so much short-termism in the market right now that is sort of adding to that "I want this investment to work really quickly. I want the payoff to be super fast." And I think in general that this is a major brewing problem, almost potentially a financial literacy problem, of the gamification of the market.

Greg Hall: Yeah, it's—I worry that you and I are now at the risk of moving into, like, a get-off-my-lawn moment where we're both frustrated by some of the, you know, the investor behaviors here. But I fully agree with you. It does remind me of, you know, when I was recently out of school and all my friends had taken up—not all my friends, but many of my friends had taken up jobs at kind of .com 1.0, you know, type companies.

And I would say to them, like, I don't get it. You're delivering DVDs and Ben & Jerry's on a bicycle, and you're an Ivy League graduate, and I know it costs more to send you here to my apartment with this than you'll ever make back from the purchase itself. And they said, Greg, you just don't get it.

Yeah. And so I don't want to fall prey to that, because I do think that optimism is a really good trait generally to have in investing. And I'm—

Liz Ann Sonders: Investing by its nature is an act of optimism. So I agree with you. You inherently have to have it to be a successful investor.

Greg Hall: But, and maybe to bring us back to the index part of the conversation, at certain levels of extreme, skepticism has to step in, right, and reassert itself. And so you would—you know, you had mentioned, you know, where we are today, about 40% of the S&P in the top 10 names. What do you advise an advisor or a client to do with that information?

How do they then think about the risks in their overall portfolio, and what do they need to do to—maybe they're comfortable with that and they want to press it, or maybe they want to start thinking about diversifying away from it.

Liz Ann Sonders: I mean, the most important answer to a question like that is it depends on the client. And I often bristle if, whether it's in the financial media, somebody gets a question, "What are you telling investors to do now?" and they'll throw out some specific percentage asset allocation to a variety of asset classes. And I think, well, who's the investor?

What are their long-term plans? What's the risk tolerance? What's your financial risk tolerance? What's your emotional risk tolerance? Do they have concentrated positions because they've been, you know, a lifelong employee at Nvidia? There's so many questions that go into, so what do you do here? We do know that there is concentration in a lot of portfolios.

Even with some rebalancing along the way, it's still the case that, having just celebrated the four-year anniversary of the bull market, when the bear market ended in 2022, in October, only tech and communication services have outperformed the index itself over that period of time. The other nine sectors have underperformed. So certainly, absent any rebalancing, we know there's a weight in positions in those sectors.

And it's not as simple as just saying, well, you know, scrap the cap-weighted S&P, just buy the equal-weighted S&P. It's also not as simple as saying, well, go defensive, you know, think about a sector like healthcare as opposed to tech and comm services, because that's still somewhat monolithic. I think this is an environment where the specificity should be around factors and characteristics and attribution.

So looking for, especially in this environment, companies that have many of the attributes that a lot of the AI-themed names have, which is really, you know, positive earnings outlook and positive earnings revisions, but you really have to bring balance sheet factors into the mix. So it's not just about profitability, but, you know, high interest coverage versus low interest coverage, low debt-to-equity versus high debt-to-equity, cash flow–type factors, profit margin stability–type factors. So almost intuitively thinking, what's overly ample right now? What's dear right now? What should we value more in this unique backdrop from a macro perspective? And then take a factor approach, sometimes as an overlay to a sector approach or a style approach. It's also not as simple as just growth and value.

And I get driven crazy how simplistic I hear the discussions that are had about growth versus value. It'll be, well, I like growth, or I like value, or growth is doing well, or value is doing well. And I always think, well, what are you talking about? Are you talking about the actual characteristics of growth and value? That's at the factor level.

Are you talking about our preconceived notions of what are growth stocks and what are value stocks? You know, energy generally are considered value stocks, but they have the strongest earnings profile right now, so right now they're also growth stocks. Or are you talking about the indexes labeled with growth and value? And there you get massive differences based on how they're constructed, whether it's a Russell index, whether it's an S&P, when the rebalancing period happens, which is about six months apart between the S&P and the Russell indexes. And as a result, you can get a really wide performance spread. So I think this is an environment maybe generically thought of as stock picker's market. But you do have—you've got to go more granular.

This is not a monolithic-type market where you can just make a couple of really easy decisions, whether it's at the cohort level, like a Mag Seven, or the sector level. This is when you want to actually look for the characteristics that are going to serve you well, given the unique circumstances of the environment.

Greg Hall: Yeah. And then there's also, you know, I think maybe the final growth versus value trope that I sometimes hear: what people are really saying is, I like buying expensive stocks instead of buying cheap stocks, right? Exactly. Defined by P/E, which, you know, is a little counterintuitive, but

Liz Ann Sonders: Exactly.

Greg Hall: Hard to argue with on recent track record. Do you think—so one of the things that's kind of interesting to me is, in the fixed income world, we're very well used to indices being highly imperfect, you know. In fact, they're almost a little bit of an oxymoron or a misnomer, because what constitutes the index is not investable, right?

And so we have index proxies. But even then, you know, by virtue of just, you know, heavy, heavy concentration in Treasuries and mortgage-backed securities, agencies, you know, and leaving out huge categories of what exists in the fixed income world, we sort of take it as a given that the index is a fairly imperfect—a very imperfect way of investing in fixed income. I'd say, you know, maybe this reflects our bias a little bit.

Like, we're always more comfortable claiming that equity indices do, you know, a better job. And the data backs that up, you know, over many, many decades of active managers versus passive managers. When you say it's a stock picker's market, do you think that this affords an opportunity? And should advisors be looking at active management in equities a lot more closely than maybe they have over the last decade or so?

Liz Ann Sonders: Yes, but not necessarily at the exclusion of passive vehicles. We've always espoused considering having both active strategies in portfolios and passive strategies in portfolios. And again, it ultimately goes to who the investor is, what the short-term and long-term goals are, need for income, tolerance for volatility—I mean, blah, blah, blah, the list goes on and on.

But, you know, we talked earlier about, earlier in the year, finally starting to see some breadth improvement. In fact, it was at a time where a lot of the mega-cap tech and AI-related stocks were in their corrective phase, but you had much greater participation by the rest of the market, the other 493, as it's often called, that you had for a little while there in the beginning of the year one of the best starts to a year for active relative to passive.

That gave way when the war began, and we started to see a narrowness kick back in again. Now we're starting to see a little bit of a broadening out again. So active is not going to—even if the playing field is a bit more level for active, that doesn't mean month after month, quarter after quarter, active is going to beat passive.

But I think this is a ripe time to be considering both strategies within portfolios.

Greg Hall: Yeah. No, we remember the outset of the year fondly as well. You had a little bit of a Goldilocks situation where you could still very much believe in the bull story of AI, and, in fact, we interpolate this, but felt like the deflationary impact of AI, or the potential disinflationary impact of AI, was prominent in the market, and that was helping to keep rates at lower levels.

And that seemed like—it was obviously healthy from a return standpoint for both equity and bond markets. But then when the conflict in the Persian Gulf came around, we sort of went to everything just focused on that one factor, appropriately so, and that's really just changed the nature of the year. Maybe what I hear you saying is we might be at a place where the factor spread will increase, and we'll be thinking about more than just energy-driven inflation over the next six, nine months.

Liz Ann Sonders: Oh, well, you know, we've talked about breadth a bit. There's breadth in the inflation statistics. This is not just an energy story anymore. In fact, even staying on energy for a moment, we haven't started really to see the ripple effects of diesel inflation. That's going to be a longer-lasting impact given the feeder through every, you know, good that is transported in some way or another and the seasonality of the, you know, winter that is approaching. AI, even if you're a staunch believer that it's eventually deflationary or disinflationary, it's not right now. It's an inflationary force right now. And, in fact, the build-out, the boom, rests a lot on imports, and import prices are rising more sharply. Exporters to the United States of what is needed for the infrastructure build-out have pricing power right now, and they are using it, which is interesting because the line item in GDP that captures business capital spending, which mostly it's AI, is that nonresidential fixed investment that's been booming, generally running at about a double-digit pace.

But the trade line item, which is net exports, has actually acted as an offsetting drag. So you can cobble together the math suggesting that the AI CapEx is additive, probably 70 or 80 basis points to GDP, but you ex trade out of that, given more of it is imported than exported, that drops down to about 15 basis points.

So that's one of the missing links that I find. I get a lot of those "Oh, wow, I didn't know that" when I mention a stat like that to client audiences, or because they asked the question, with this incredible CapEx boom, why isn't it accruing more to economic growth numbers, GDP statistics? And it's because of that trade relationship.

Greg Hall: Yeah. Or even to stay on the theme of today's conversation, how is it not lifting the other 493 more than it may already be doing, right? And I think that's a really good point.

Liz Ann Sonders: Well, you know, let me stay on that for a minute, because here's another—you know, all of this spend on the part of the hyperscalers, etc., because of the change in expensing, they're not—the depreciation hasn't kicked in yet, but the—what's being purchased, those companies are booking the revenue right away. So that's another budding—not concern, as if it's a new concern.

We—you know, anybody that knows anything about accounting—and I don't know much, so don't deep dive on this accounting stuff with me. Yeah, thank you very much. But so they're worried about, okay, when does the mismatch start? Not to mention the fact that in the second quarter you had—I think it was 17% of earnings were non-operating earnings coming from investment gains.

You know, many of the big companies that have investments in the private companies like Anthropic or OpenAI, or had investments in SpaceX as it came public, they booked those gains.

Greg Hall: Corporate wealth effect.

Liz Ann Sonders: Right. And that's not repeatable. That's not going to keep happening. You also had tariff refunds that kicked in much more quickly in the second quarter. That's also not repeatable. So there's an appropriate focus on the math here. And again, why I think it is, even within AI, a stock picker's market. A lot more homework is necessary right now on all of the things that we've been talking about so far.

Greg Hall: I want to turn back to this notion of diversification in multiple asset classes. One of the things that I've noticed of late—you know, we talked about the two, usually the two largest parts of an advisor's or a client's portfolio, stocks and bonds. But the AI story is now, you know, it's in real estate, it's in private credit, it's in the alternatives categories. I would imagine you guys probably keep a weather eye on ETFs, levered ETFs, and some of the ways in which leverage kind of creeps into portfolios and exacerbates some of this concentration. Yeah. How focused are the folks that you talk to about understanding their factor risk throughout the portfolio, versus thinking about these areas—equities, bonds, alternatives—as distinct asset classes that have fundamentally distinct return profiles? Because they—done in the wrong way, they seem like they want to—they're merging together.

Liz Ann Sonders: Yeah, I worry more about—and not just our self-directed investors, but self-directed investors more broadly—who are venturing into a lot of these vehicles, whether it's leveraged ETFs, inverse leveraged ETFs, the options market, without a sufficient education and understanding of not just the risks, but how it fits in an overall portfolio. I think for what we call our advised clients, those working with a financial consultant or one of our wealth advisors or working for an advisory firm on our platform, certainly at Schwab's end, we have built 55 years of a business and a reputation on the back of financial literacy and a belief that everything that we do has to come with meaningful education. It's why we won't launch into areas or products without that sufficient education, making sure that the sort of regulatory framework is sound. But there again, the blurring of the lines between investing and gambling.

I have so many wow anecdotal conversations with people about how they're investing, everything from, well, the market's so easy, I've had luck recently just buying stocks with ticker symbols that match my family's names' initials. That's an actual conversation that I had with somebody. I had a young investor I was sitting next to on a plane not all that long ago, 23 years old.

He had just had a liquidity event—his grandfather, maybe there's an irony to how I phrase that, because his grandfather sold the porta-potty business—and he and his 20-year-old brother had gotten a decent chunk of money, and they were interviewing money managers. He had asked me what I did.

I told him, and he said, we've started to invest on our own. And he told me, and he said well, I know you're going to tell me that I'm probably being way too conservative. And I said, well, that's 100% large-cap growth equity portfolio, essentially. And he said, but there's no downside. And I said, what do you mean there's no downside?

He said, well, it just tracks the market. I said, you do—the market can go down, and you have bear markets. And he was sort of flummoxed by that. And that's just a basic example of an equity portfolio, not to mention what a lot of these more gambling-oriented people are doing with some of these riskier vehicles.

Greg Hall: Yeah. And look, I mean, I think that probably one of the reasons we have cycles is because there's always 23-year-olds, and oh, to be 23 again, and God bless them for, you know, being at the outset of their investment career. But these, you know, these time-worn lessons, sometimes you have to experience them viscerally.

Liz Ann Sonders: No question.

Greg Hall: And I guess I suppose that would underscore the need for an advisor in exactly that kind of context. I—we talk a lot on this podcast about that. That's an extreme example, I'll give you. But this phenomenon of the market has been so good for so long that people have forgotten that it—that it carries risk and it can go down.

And I think, you know, when we look at stats, you know, just on average over a huge advisor population across the country, 60/40 is so far in the rearview mirror. I think, you know, it's harder to look at cash balances. But, you know, in terms of the equity-bond split, we're more like 90/10, and that's being a little generous in many cases.

How do you think about, you know, that balance? You know, and this isn't a leading question. You—you know, obviously say whatever you like. Don't mind us. We're the bond managers over here. But, you know, it does seem like that's been pushed to a little bit of an extreme.

Liz Ann Sonders: Yeah, no, I think particularly if the extreme suggests that if you are an equity investor, there's no home for bonds in your portfolio, or maybe vice versa, which doesn't make any sense in any environment. But let me answer the question maybe in a slightly more secular way, or a much more secular way. It's something that we've been writing about and speaking about for a number of years now, which is the, to me, the definitive end of the Great Moderation era, the period that spanned from, depending on what metric you're looking at, sometimes people think of it as starting in the mid-'90s. I think of it as starting, based on the context I'm going to give you, in the late '90s and carrying up until 2022, when we got the COVID-related inflation spike and we started to normalize the monetary policy environment. Well, that environment had generally disinflationary winds most of the time.

There wasn't a lot of inflation volatility. We had massive globalization, China joining the WTO in 2001 and flooding the world with cheap and abundant access to goods and labor. We had a massive energy boom in the US, allowing us to be energy independent and therefore providing abundant and relatively cheap access to energy, save for the spike we saw in 2008.

That is also an era that gave rise to simple portfolio structures like 60/40, because in that environment, bond yields and stock prices, for almost the entirety of that 22-ish-year period of time, 24-year period of time, were moving in the same direction, because bond yields weren't volatile based on inflation volatility. They were moving up and down more based on growth and expectations about growth.

So higher bond yields without the attendant risk of or concern about runaway inflation, that's sort of nirvana for equities. Now, of course, as probably everyone listening to your podcast knows, when bond yields are going up, bond prices are going down. So that was an era where, with the exception of some brief periods, notably in 2008, bond prices and stock prices moved in the opposite direction.

So you could adopt a somewhat simple approach to allocation. I think we need to think about whether we're transitioning into, if not already in, an environment that looks more like the 30 years that predated the Great Moderation. I nicknamed it the temperamental era, from the late '60s to the late '90s, and for almost the entirety of that 30-ish-year period of time, the relationship between yields and stocks was the complete opposite.

There was an inverse correlation almost the entire period of time, which meant prices were positively correlated. That was also an era, though, when for individual investors, there was such limited access to diversification and non-correlated assets, taking—you know, the ability to take an endowment approach. That was the days of private banking and, you know, kind of, you know, in the early part of that era, [unclear] Schwab being in existence.

So today, assuming we're in an environment like that, number one, it doesn't mean 60/40 conceptually is dead, but it does probably mean that you want to take a broader approach to thinking about diversification. And the ability to do that has never been greater because of democratization of access to other asset classes in the private markets and the public markets, and the ability for investors to get a more diversified portfolio without an exorbitant cost from a fee standpoint.

Greg Hall: Yeah, I think—I mean, I think, look, everything you're describing is totally reasonable. I think what we would say is the flip side of the environment that we're in now relative to the Great Moderation is you can actually achieve yields in high-quality fixed income of, you know, portfolios with, you know, yielding seven, eight, eight-plus percent without a lot of, you know, disproportionate risk to get there.

And so if the answer is somewhere between 100/0 and 60/40, I think we're very comfortable with that. We also believe, I think, in diversifying into newer categories. We think, you know, you and we prefer probably on an advised basis and a non-gambling format with terrific partners like yourself. Absolutely concur that that has a place in the portfolio.

But, you know, in Dan's comments last week, which I'll echo a little bit here, is just, you know, the ability to produce high-quality income as ballast in the portfolio, to have an option on, you know, some great price performance. If we do see disappointment relative to the lofty expectations embedded in equity markets today, that's a compelling story because of the sort of—the starting, the intrinsic level of yield.

Liz Ann Sonders: Absolutely, absolutely.

Greg Hall: All right, great. What do you—I'm going to—this may be my last question. It is a tension that we feel in the market every day, and I'm just sort of curious your take on it. Despite maybe the wobbles over the last week or two, the equity market's resilience in the face of a relatively rapid move up in rates, I think, has been a little surprising.

I think that—I think earlier in the year on your pod, I remember a conversation, maybe it was between you and Kathy, or probably Collin, because it was after March. You were talking about how the aggregate or the absolute level of rates is maybe less important than the rapidity with which they move, right, for equity prices. Right.

So now we've had a rapid move, and the market has seemed pretty resilient in the face of it. How do you think about that? How would you explain it?

Liz Ann Sonders: Yeah. Well, the market at the index level has been quite resilient through all of this. But if you go down a layer or two underneath the index level, you do see where the pain has been inflicted from a higher yield environment, not least being the real estate sector, both from a stock market perspective but also in the economy as well.

So that's where you see the sensitivity ties that are a bit tighter. It's also the case that this has been a highly, highly rotational market. So the S&P at the index level, you're right, has been resilient. Didn't even have a 10% correction so far this year—was limited to nine and change in the February–March period of time when we had that pullback phase.

But the average member within the S&P has had a 27% drawdown year to date. So that is bear market level. It just didn't happen all at once. It happened through a process of rotation. It's more stark for an index like the Nasdaq. The Nasdaq at the index level did have a correction. 13% was the drawdown in that February–March period of time.

But the average member has had a 47% drawdown on a year-to-date basis. You're also seeing an incredibly wide spread at times that opens up between, say, the best-performing sector, even on a single day, and the worst-performing. As you and I are sitting here taping this, you've got the healthcare sector—I mean, the consumer staples sector—up about 3% today, and you've got the tech sector down 3% today. That's a six-percentage-point spread just in a single trading day that isn't even over yet. You've recently hit a record-high share of the S&P 500 trading with a negative beta on a day-to-day basis, meaning moving in the exact opposite direction of what the index is doing.

So the volatility of equity—of the S&P's constituents, you know, VIX EQ versus regular VIX, just the volatility of the index—VIX EQ is running at twice the pace of the overall volatility. So you can just stop at the cap-weighted index and say nothing to see here, lots of resilience. But the fuller story is told underneath the surface of the indexes. I don't think—you know, I already mentioned that the S&P has really become just kind of a stealth index representing AI.

The index, as a result, it's not broken. It's just, its job has changed a little bit. It is a proxy for AI. But what I also think is happening, one of the reasons why you're seeing these periods of improving breadth, we also may now be in the phase of who are the adopters of AI, and where is that bearing fruit quickly.

And healthcare, I think, is one of those sectors. It certainly was a sector that had the low-hanging fruit of inefficiency, not to mention what AI ostensibly can do with diagnostics and treatment. So the AI story doesn't have to die. I think it's just shifting attention now to a bit of, all right, how do we think of AI as it relates to the adopters, not just the creators?

Greg Hall: Well, first of all, that's the perfect answer to a question that I now feel kind of dumb for asking, because I asked you why the index was so resilient amidst the whole conversation about how the index is not necessarily representative of what's going on in the broader economy. And so thank you. You know, you just so eloquently pointed out some of the stuff that's going on under the surface there.

And then I would say from a credit perspective, you know, fully, fully agree with what you're saying, the impact of AI for positive in maybe a sector like healthcare. But then also, you know, we point out to clients that part of what AI will do will be to disrupt and damage and threaten, you know, quote-unquote, old economy businesses.

Absolutely. And so that will be seen in—

Liz Ann Sonders: And create new economy businesses that, in many cases, we haven't even envisioned yet. That's why I'm generally an optimist as it relates to even labor market disruption. You go through the destruction period, and that's just natural. That's Joseph Schumpeter. But ultimately you end up with industries and types of jobs and functionalities that you couldn't even have imagined a few short years ago.

Greg Hall: And quality of life and the ability to do things faster, learn more quickly. I mean, it's the irony of being here at PIMCO. We're—at an individual, at a company level, we're extraordinarily optimistic and excited about what AI is doing for our business, but also mindful of the fact that expectations can maybe exceed the pace, and that it will not come without some disruption along the way.

Hopefully not to people listening to podcasts, Liz Ann, because this has been incredibly enjoyable, and I'm so glad we did this. The time has flown by.

Liz Ann Sonders: It sure has.

Greg Hall: I hope you'll come back and join us again.

Liz Ann Sonders: I hope so too.

Greg Hall: I hope we can do more, quote-unquote, in real life together. If I can say so, good luck with Schwab Impact.

Liz Ann Sonders: Thank you very much.

Greg Hall: Thank you. Always an amazing show. And yeah, we'll wrap it up there. For everybody listening, thanks for tuning in today. I hope you really enjoyed this conversation with Liz Ann Sonders. Would highly, highly, highly encourage you to check out her podcast with her partner Collin, On Investing. It's available at Apple. It's available on Spotify. While at Apple and Spotify, you should also feel free to check out other episodes of Accrued Interest.

And I'd be remiss if I didn't ask you to like and subscribe. If we know you're out there, it does help us bring you this kind of content and devote more time and attention to delivering our ideas and folks like Liz Ann's ideas in this format. If you want to double-click on any of the topics we discussed today, visit us at PIMCO.com in the US or wherever,

whichever country you happen to be listening to this in. If you identify yourself as a financial advisor, you'll be taken to Advisor Forum. That is our one-stop shop for you to get what you need on an efficient and practical basis from PIMCO, to digest the info and then head out and spend more time with your clients, helping them make good decisions in a very rapidly changing world.

With that, Liz Ann, thank you so much again, and we'll talk to everybody next time.

Liz Ann Sonders: Thanks, Greg.