Can the Markets Leave a Brutal 2022 Behind?

MIKE TOWNSEND: We made it to the final month of 2022, and from an investing standpoint, I think we're all ready to flip the calendar and get a fresh start in 2023. It's been a tough year across the board. The economy remains on unsettled footing, with inflation continuing to be stubbornly high. The S&P 500^® was down more than 15% for the year as the markets opened on December 5. The NASDAQ Composite was down more than 27%. The Russia-Ukraine war, China's zero-COVID policy, and the strong dollar are all contributing to a struggling global investing environment. Even bond investors who usually see positive returns when stocks are down have had it rough in 2022. And Bitcoin, down more than 63%.

So will turning the page to 2023 see a reversal in these trends?

Welcome to WashingtonWise, a podcast for investors from Charles Schwab. I'm your host, Mike Townsend, and on this show our goal is to cut through the noise and confusion of the nation's capital and help investors figure out what is really worth paying attention to.

It's been such a frustrating year for all types of investors—traders, long-term stock market fans, fixed-income investors, cryptocurrency enthusiasts, global investors. So, today, instead of giving my usual Washington updates, four of Schwab's experts who are frequent guests on WashingtonWise are joining me to talk about what has happened this year and where investors should be focusing as we head into 2023.

With the Federal Reserve poised to meet next week, I want to begin with Kathy Jones, Schwab's chief fixed income strategist. Welcome back to WashingtonWise, Kathy.

KATHY JONES: Thanks for having me, Mike.

MIKE: Well, Kathy, I want to kick off this episode talking about the Fed, because what they do seems to have such an outsized influence on the markets, even if it is just short-term. The consensus seems to be that we'll see a slowdown in the pace of race hikes, with the markets generally expecting a 50-basis point hike this month after four consecutive 75-basis point hikes. So what, in particular, will you be looking to hear from the Fed in its statement and in the Chairman's press conference that will offer clues about where things are headed in 2023?

KATHY: Well, Mike, it is pretty clear from comments by various Fed officials that the next rate hike is going to be 50 basis points, not the 75 we've been experiencing, and that's a slight moderation in the size of rate increases. But what we'll really want to hear about is how high the Fed thinks it needs to take rates in this cycle to slow inflation. The market is pricing in a peak, or a terminal rate, of about 5 to 5¼%, but there are some at the Fed indicating that they would like to see a higher rate.

Now, the Summary of Economic Projections will be released at this meeting, and that includes the dot plot, where the views of all the various members are shown about where rates are expected to go over the next year or two. And we usually look at the median estimate, which likely will come in, I'm guessing, at about 5 to 5¼%. But the range could be really large, with some members seeing much higher rates, while others not seeing rates going even to 5%. So that's going to be interesting to judge the dispersion, where the Fed is as a group in terms of their agreement on where rates are going.

Now, lately, the market has gotten a lot more information from Fed Chair Powell's press conferences than from the statements or even the Summary of Economic Projections. You know, he tends to let us know what's of most interest to the Fed when he speaks, and I think the main issue is how they're seeing the job market developing. That's going to drive policy decisions. It's clear that the Fed wants to see job growth and wages slow down before declaring victory over inflation.

MIKE: Well, it will be interesting to see where the Fed ends up next week. I think everyone will be watching that pretty carefully.

Well, I want to switch gears and talk about bonds, because right now, the yield on short-term bonds is greater than the yield investors can get on bonds with longer terms, what's known as an inverted yield curve. That's completely backwards to how it should be, and it's often seen as a red flag that recession is on its way. But I've heard talk from analysts that it could be just the opposite, that the Fed is getting a handle on inflation, and the economy may start to return to normal. So how are you deciphering the message from the yield curve, and what are the signals that you'll be watching that would indicate that inflation is abating?

KATHY: Well, you're right that this is a hotly debated topic right now among economists. So in the past, an inverted yield curve has been a very reliable signal that a recession is coming within 12 to 18 months. It sometimes seems like voodoo to people, so I think it's worth pointing out why that's been the case.

Banks tend to borrow in the short-term markets and make loans that have longer terms. For example, a bank may get its funding by borrowing from other banks at overnight rates, the fed funds rate, or perhaps by issuing short-term paper that's purchased by a money market fund or by issuing CDs. Then they use those funds to issue loans, and, typically, the loans have longer terms. So, for example, a car loan might have a term of three to five years or even longer these days. So when the cost to the bank for funds is higher than what they can earn on a loan, they're naturally reluctant to make those loans. And when banks stop making loans, or curtail their lending, or raise the cost of those loans to cover their costs, the economy tends to slow down.

Some economists are making the argument that a lot of lending is taking place outside of the banking sector, so the yield curve inversion isn't as meaningful this time around as it used to be. I have my doubts about that, but that's the argument.

But I do agree that the market is signaling in either case that inflation is going to abate because of Fed tightening. I mean, that's really what an inverted yield curve tells you. It reflects expectations that the Fed's policies will slow the economy and bring inflation down. Investors simply aren't demanding a higher yield to invest for a longer time horizon because they see inflation coming down.

So, ultimately, it's kind of all one and the same. There's really no distinction between these arguments. Just a question of whether the signal that an inverted yield curve will actually lead to a recession. Personally, I wouldn't bet against it. It has a great track record. We're seeing plenty of evidence that inflation is abating. Wholesale prices for everything from lumber to oil to steel have fallen back to pre-pandemic levels, as has the cost of shipping goods.

But it's the service sector inflation that the Fed is really concerned about, things like healthcare, the cost of restaurant meals, and rents. Those have been slower to come down. However, we are starting to see signs that they are slowing down. The real key for the Fed will be when wage growth slows down to probably about 3% or so. That means that wages, or the spending power of consumers, has fallen to a level that policymakers deem consistent with stable inflation. Right now, wages are running at about 5%.

MIKE: Well, I think we can all agree that 2022 has been kind of a weird year for the markets, and it's upended some long-held beliefs for a lot of fixed-income investors, in particular. That's because bonds typically fare much better when stocks are declining. It's part of the reason for holding a mix of stocks and bonds in your portfolio. But for most of this year, stocks and bonds have declined together. So do you think that's going to continue? What should fixed-income investors be doing as they confront this situation?

KATHY: Well, we don't expect it to continue. In fact, quite the opposite. 2022 has been an anomaly, with bond prices falling sharply along with stock prices. It's really only happened a handful of times over the past 50 years, especially to this magnitude. The issue with bonds has been the combination of a very low starting yield, near zero for much of the Treasury market, and then a rapid rate of tightening by the Fed. In fact, it's been the most rapid rate hiking cycle in over 40 years.

So going from zero to 4% in a matter of six months was a huge and nearly unprecedented move, and that's pushed bond prices down sharply. And there was no cushion from higher coupon or current income to offset that price drop. But in 2023, it's just the opposite. Bond yields are much higher than they were a year ago, and the coupons offered, or the current income on newly issued bonds, is significantly higher, and that provides an offset to price declines if they even occur.

Additionally, we think the bulk of the Fed tightening is likely behind us. In fact, the market's expecting the Fed to start cutting rates in late 2023. That means bonds should perform well. We're actually pretty optimistic about the outlook for the bond market. Investors right now can build portfolios generating yields in the 4 to 5% region, and very high-quality bonds, like Treasuries, investment-grade corporate, and investment-grade municipal bonds, without taking a lot of credit risk or duration risk, and that's really a big change from the world we've been in for a while with yields so low. And it's a really good option for investors looking for income, for that diversification from stock, and capital preservation.

MIKE: Well, as always, Kathy, it's great to get your perspective on the bond market. That's Kathy Jones, Schwab's chief fixed income strategist.

Well, let's turn next to the state of the economy and the equity markets. And there's no one better to talk about those two topics than Liz Ann Sonders, Schwab's chief investment strategist. Welcome, Liz Ann.

LIZ ANN SONDERS: Hi, Mike. Nice to be here. Thanks for having me.

MIKE: Well, Liz Ann, the market has been choppy this fall, with brief rallies and then declines. I think it's made a lot of investors wary. So what are the key signals that you're watching to feel more confident about a market turnaround?

LIZ ANN: If you think back to the start of the year, which the high in the market was, at least for the S&P 500, was on January 3, so really just as we launched the 2022 year, the bear market that then unfolded actually didn't have as a backdrop, at least not for the first half of the year, weak earnings. So it was almost solely driven by expectations for tighter Fed policy. And then, of course, by March, the Fed had launched its tighter policy, and it's now turned into the most aggressive campaign in at least, you know, four or five decades. And that had the effect of putting downward pressure, especially on higher multiple segments of the market, helps to explain why tech has done fairly poorly.

Now I think what's still ahead of us is the weakness to come in earnings. So whereas the first half of the year was defined as one where P/Es came down without the E coming down because of inflation. Now I think inflation is starting to roll over. That should mean maybe less downward pressure on P/Es, but, unfortunately, upward pressure because the denominator, the E in the P/E, probably still has more to go on the downside.

So I think labor market weakness and earnings weakness is still ahead of us, but a lot of the monetary policy risk and inflation risk is behind us.

MIKE: Let's talk about the labor market weakness you mentioned. Obviously, we've had some high-profile layoff announcements in recent weeks, particularly from tech companies—Amazon, Meta, of course, Twitter, and more—but that has not yet seemed to ripple widely across the economy. The Fed has been focused on fighting inflation, and to help that effort has actually been pushing to weaken the jobs market. So how do you see the job market in the months ahead playing out?

LIZ ANN: It's a very mixed picture, and it really depends on what particular labor market metric you're focusing on. Probably the two most popular and widely watched ones are the first two headlines announced as part of the monthly jobs report, which for November was a better-than-expected payrolls number and an unchanged unemployment rate at 3.7%. The rub is that under the surface, and even within the labor market, the monthly Labor Market Report, there are some cracks, kind of under the surface, that in my mind aren't getting the attention that they deserve. You mentioned, Mike, layoff announcements increasing. There's, you know, an increasing number of hiring freezes being announced. Obviously, those are precursors to then what makes its way into headline figures like payrolls and the unemployment rate. The unemployment rate, by the way, as a reminder, is one of the most lagging of all economic indicators. So it's the last thing, really, to turn back higher.

But what's really interesting, and this was borne out in the most recent jobs report for November, is the Establishment Survey, as it's called by the BLS, Bureau of Labor Statistics. It's what generates the payroll numbers. And then there's a separate survey called the Household Survey that generates the unemployment rate. And that's because what the Establishment Survey does is it counts jobs. Therefore, you can't calculate the unemployment rate from that. Hence, the Household Survey, which counts people. The divergence between the two is really remarkable in this environment. In the last eight months, the Establishment Survey suggests that the U.S. economy has added 2.7 million jobs. The Household Survey, which has actually declined in half of those eight months, suggests that the economy has added only 120,000 jobs.

So is it 2.7 million or is it 120,000? And I think the answer is maybe somewhere in between, but, unfortunately, probably closer to the Household Survey. It tends to lead at important inflection points. The Payroll Survey also has an embedded adjustment, and it's an estimate that the BLS makes every month for how many businesses were born and how many businesses died. And at this point, typically, in a cycle, their estimate for new business births are always way too high. And I think that's been the case recently. And the Household Survey picks up things like multiple job holders. So if one of us has to take on a second job or maybe a third job, those one or two additional jobs might get calculated into the Payroll Survey as brand-new jobs. Whereas it's still one employed person who has now had to take on a second or third job in order to make ends meet. So very different messages that come from the innards of a lot of this data.

MIKE: Let's pick up on that in a more broad sense. 'Cause I think one of the odd things about this economy is that not everything has moved in lockstep over the last year or so. Inflation remains high, but unemployment remains low. Gas prices rose steadily for the first half of the year; they've mostly fallen during the second half of the year. We've seen odd spikes this year in different parts of the economy, whether it's food, or used cars, or now, housing. You've been talking recently about rolling recessions, where parts of the economy clearly signaled recession, but not necessarily at the same time as other parts of the economy. Do you think this is going to continue in 2023? And are there sectors that could be leading the way out? I guess the question at the end is how do investors find opportunities in this environment?

LIZ ANN: Yeah, it's a great question. And the concept of a rolling recession is not brand new, but I think it's probably the most accurate description of the environment we're in, and probably to a greater degree than anything we've seen in modern history. And it's really just the nature of the pandemic itself. If you think back to the start of the pandemic when everything, not just in the U.S. but globally, went into lockdown mode, that was a time when, of course, the stimulus that then kicked in in the U.S., massive both on the monetary side and on the fiscal side. That stimulus caused a surge in demand, but the problem was that surge in demand and the surge in the money to do something about that demand was forced to be funneled into the goods side of the economy because there just was no access to services at that point. That was the breeding ground for both the sort of launch, quick launch, out of official recession that happened because of strong demand.

It was also the breeding ground for the inflation problem with which we're still dealing. But at that early stage, it was highly concentrated on the goods side of the economy. That has now rolled over, and I would say inclusive of housing and housing related. That's now rolled over, not just in the economy, housing definitely in recession territory. Many of the goods-oriented segments of the economy, particularly in the retail sector, are absolutely in recession. But now we've had the pick back up in services and the pent-up demand on the services side. But we've seen now disinflation on the goods side, but that's given way to inflation on the services side. So we've seen this weakness sort of roll through not just the economy, but inflation, too.

The second part of your question as to will that continue and could there be areas that start to pick back up in the event, say, services falters, the labor market falters? Possibly, but probably not with enough force to prevent what will eventually probably be defined as a traditional recession and such declared and dated by the National Bureau of Economic Research. They're always very, very late in declaring and then dating recessions. So there's no reason to think that's coming imminently, but it's hard to come up with a scenario where assuming the labor market weakens alongside services, that the conditions would be there for some major offset coming from non-services and manufacturing side, only because service is such a large driver of our economy. Assuming the labor market gets hit, that's when I think it starts to look and feel maybe like your more traditional recession.

Mike, the other part of the question was more market-related, and whether investors can find opportunities, and several themes for us over, I'd say, the past year or so. Number one, we really haven't been terribly focused on sector-type decision-making, overweights, underweights. We've been sector-neutral just because of volatility that we expect, but also believing that investing based on characteristics at the individual company level makes more sense than trying to make a broad sector call in this environment. And that approach has really worked, and it's in conjunction with a market backdrop that has shifted from being very capitalization-weight-oriented. You know, the big cap tech and tech-oriented stocks sort of drove the market. You could look at them monolithically.

That is not the case right now, and, really, we've seen leadership give way to what I call the average stock. And the characteristics that have defined more consistent outperformance are in keeping with what's missing in the current environment. So looking for companies with positive earnings revisions, positive earnings surprises. In a high-inflation, high-interest-rate environment, or rising-interest-rate environment, you want to look for companies that have strong balance sheets, lower debt levels, higher cash. You want to look for companies that have strong free cash flow, often thought of as shorter duration stocks, where their profitability isn't way into the future, and then you have to worry about interest rates going up and discounting profits that are way into the future. You want to look for companies that have that cash flow and that profits right now. So shorter-duration stocks. And then in an environment of spikes in volatility as we've seen, look for the types of stocks that tend to have low volatility. And you can apply that screening methodology across all segments of the market. You don't have to make a sector call or two, or large-cap versus small-cap. Invest based on characteristics. That's been a really important theme.

MIKE: Well, thanks, Liz Ann, as always, for your great perspective. That's Liz Ann Sonders, Schwab's chief investment strategist.

Well, next up, I'd like to pivot to the overseas markets. I'm pleased to welcome in Jeff Kleintop, Schwab's chief global investment strategist. It's great to talk with you again, Jeff.

JEFF KLEINTOP: Thanks, Mike. Glad to be with you.

MIKE: Well, Jeff, central banks around the world are grappling with the same inflationary environment that the United States is, but they're not necessarily acting in the same way. The U.K., for example, had to reverse its plans to tighten its balance sheet and ended up buying gilts. Japan had to buy bonds due to the yen going so low against the dollar. So what are you watching in terms of how other central banks are making policy decisions? Do those give any clues about how things will go in the U.S., and is there something the Fed and we, as investors, can learn from them?

JEFF: Those circumstances were unique, and they didn't change the rate outlook. You know, in the U.K., the bond buying was driven by a short-term political change. And in Japan it was due to a longer-term unchanged interest rate policy. Neither was driven by the recession or inflation situation―that's the focus of most other central banks today.

Now, while the pivot to rate cuts doesn't seem likely in the near term, most major central banks seem to be signaling a step down in the size of the rate hikes, or even a pause. The U.S. Federal Reserve has signaled a slowdown in the pace of hikes from 75 basis points in November to just 50 basis points in December, and the Bank of Canada already did that, from 75 to 50 back in late October, and the central banks of Australia and Norway stepped down from 50 to 25 over a month ago. And now we've also seen the central banks of one of the largest emerging- market economies, Brazil, and the central bank for the largest emerging-market economy in Europe, Poland, both left rates unchanged at their last meetings.

So the stock markets offered Thanksgiving for this with an early "Santa Pause" rally. The MSCI World Index of Global Stocks is up over 15% in October and November. That's the strongest gain for any quarter since the pandemic rebound in the second quarter of 2020.

MIKE: Well, you know the holiday season is upon us when we're talking about the Santa Pause rally.

Well, Jeff, it seems in recent months that just as we start to see improvement anywhere in the economic landscape, something else goes off the rails. In the supply chain, everything seems to circle back to China, which is seeing another spike in COVID cases, just as the world is anticipating an easing of China's zero-COVID policy. We've also seen rare public protests in the country. So what are the implications for China and for the global economy?

JEFF: China's authorities are preparing to reopen and end the zero-COVID policies that have held back the economy for the past three years. And in reaction, the MSCI China Index was up 29% in October. That compares to just 5% for the S&P 500 index. Now, this surge in Chinese stocks has propelled outperformance of overall emerging-market stocks, but the potential reopening poses upside risk to inflation, and that comes just as central banks appear to be stepping down their rate hikes.

So despite these periodic protests, we think it's unlikely China will suddenly and materially step away from its zero-COVID protocols before the end of winter, when respiratory infections typically rise. Already COVID cases have climbed to new highs, according to China's National Health Commission, and the geographic spread of the virus is the widest it's ever been with 203 reported outbreaks in November.

When it comes, China's reopening may be like most other countries' reopening experiences, with economic growth accelerating and inflation picking up. A surge in demand from reopening may not be balanced by a similar surge in supply. While China's authorities allowed demand to slump, they went to great lengths to prevent disruption of production and supply chains. Any reopening beginning in, say, March or April is likely to be gradual, but it could still lead to a surge in pent-up spending in the world's second largest economy. 1.4 billion consumers could lead to a rebound in global inflation for both commodities and goods. And, again, that may come just at the point that central banks were planning on pausing their rate hikes and could disappoint the stock market.

So as China moves toward reopening in 2023, we'll be watching developments carefully to assess that balance between reopening excitement and inflation worries on the stock market.

MIKE: China, of course, is just one piece of the geopolitical puzzle, and as we look toward 2023, geopolitical risk seems particularly high. Obviously, the Russia-Ukraine war slogs on and continues to have massive implications for the global supply chain, for oil prices, for food prices, and more. North Korea has shown a new level of aggression with its flurry of missile tests. And China-U.S. relations, overall, remain tense. These and other situations have spooked a lot of investors from being too invested in the global markets. So how should investors be thinking about the global investing environment given all these uncertainties?

JEFF: It's important to remember that geopolitical risk is an ever-present part of investing. I mean, despite all those things you mentioned, international stocks have actually outperformed U.S. stocks in 2022, even with this year's big gain in the U.S. dollar acting as a drag. The outperformance by international stocks might continue in 2023. International stocks possess more of the characteristics like high dividend yields and lower price-to-cash-flow ratios that have contributed to outperformance within and across sectors and countries this year.

Also, earnings growth is stronger outside the United States and is expected by analysts to remain so in 2023. For example, the year-over-year growth for earnings for S&P 500 companies in the recently reported third quarter was 4.1%. Now, compare that to the 30.5% for companies in Europe's STOXX 600 Index. You know, combined with lower valuations, this has really helped international stocks outperform, despite those geopolitical challenges. And that outperformance may become even more pronounced with a pause or reversal in the sharp rise of the dollar.

All that said, there are plenty of reasons to expect elevated volatility, at least in early 2023. The stock market has moved by more than 5% up or down in each of the past six months. And volatility might remain high as the global recession lingers, central banks step down rate hikes, and China's reopening introduces upside risks to inflation, accompanied by threats posed by potential geopolitical developments.

So rather than try to rotate among groups of stocks, or try to insulate from elevated volatility, or even try to time a recovery or a geopolitical event, investors may want to simply stick with the characteristics that have been working in both up and down markets in 2022.

MIKE: Well, Jeff, always great to hear your thoughts on the global investing environment, so thanks for being here today. Jeff Kleintop is Schwab's chief global investment strategist.

Finally, I want to conclude today by talking with Randy Frederick, Schwab's managing director for trading and derivatives and our resident cryptocurrency expert, about what's going on in the ever-crazier cryptocurrency marketplace, as well as what is happening with active traders in the equity markets. Randy, thanks so much for joining me.

RANDY FREDERICK: Always great to be with you, Mike.

MIKE: Randy, last month saw the incredible implosion of FTX, the second-largest crypto exchange in the world, and we're continuing to see the fallout affecting other crypto firms. This situation has accelerated talks on Capitol Hill and among Washington regulators about creating a better regulatory framework for crypto. So two questions. First, has the crypto ecosystem melted down to the point that it needs to re-create itself, including more governance? And second, given that cryptocurrency was created to be outside the mainstream financial system, will more regulation be good or bad for the industry?

RANDY: Well, whether the industry wants to re-create itself or not, it's been happening anyway over the last 12 months, as all of the major cryptocurrencies have lost 70% or more of their value. You know, cryptocurrencies were born in the aftermath of the great financial crisis when Wall Street and big banks were bailed out despite being heavily regulated and despite contending that they could be self-governed. While I'm a capitalist at heart, self-governance, I see that as a utopian dream in a dystopian world. In 2008, Wall Street proved that self-governance doesn't work, and the crypto industry has proven it again in 2022.

And therein lies a great irony. Many crypto investors have been lured, not just by the potential for huge profits, but the fact that the industry operates largely outside of mainstream finance, something they perceive as a leveling of the playing field. They believe the little guy isn't at a disadvantage to institutional money and the very wealthy, but the legitimization that will come from further regulation will inevitably allow those same wealthy and same powerful players as in mainstream finance to gain an advantage.

When I attended the Consensus Crypto Industry Forum in Austin back in June, there was an obvious tension between those who prefer an unregulated industry despite systemic risks, and those who prefer a regulated industry that would almost certainly advantage the wealthy and powerful. They are mutually exclusive. You know, Mike, it shouldn't take a massive fraud case like FTX to get regulators to pay attention. FTX is far from the first fraud, but it was the biggest, at least so far. You know, as we've talked about many times in the past, the crypto industry has always been in need of more governance; they just didn't always want it. Unfortunately, human nature is such that it often takes a major event and lots of people getting hurt, whether that's physically or financially, before obvious problems and vulnerabilities are addressed.

The meltdown of Terra Luna and the Terra USD stablecoin back in May of this year was estimated to have cost investors up to $40 billion, and yet it did little to advance the legislation proposed by Senators Lummis and Gillibrand this past June. Perhaps it was because the algorithmic stablecoin structure was just a bad idea, and no fraud or misappropriation of funds was alleged.

Treasury Secretary Janet Yellen, SEC Chair Gary Gensler, and many others have been warning for a couple of years now that stablecoins present a significant risk to financial markets. And I've been warning for quite a while that even the largest stablecoin, Tether, which has more than $65 billion in market cap, could also be a systemic risk, and yet we're probably still many months away from any legislation to protect it.

The greatest crypto irony, perhaps, is that the one thing the industry needs most is the one thing it was created to avoid, and that's government oversight and regulation. There's little doubt in my mind that more regulation would be good for the industry.

MIKE: Well, Randy, there's no question that this has moved to the front burner on Capitol Hill, and we'll see how it plays out in 2023. But as you and I both know, it can take Congress a long time to reach consensus on an issue as complicated as this one.

Well, Randy, I want to switch gears. You spend a lot of time in your work focusing on what traders are doing, so I want to get your take on how they're feeling. In Charles Schwab's latest Trader Sentiment Survey for the fourth quarter, most of the survey respondents said they think the U.S. is headed for a recession, if we aren't already in one, and they don't see interest rates coming down in 2023. That's probably how most of us feel. But I found it interesting that 68% of respondents said that while they're still bearish overall, they see opportunities. Now, these are traders, not long-term investors, and they're putting their money into the markets more frequently than most investors. So what can we learn from the fact that traders are still active in the markets and still finding opportunities out there?

RANDY: Well, that's a very interesting observation, Mike. First and foremost, I think we need to recognize that how people feel and what they actually do are often very different. Most traders only trade the long side of the market, so if they were truly bearish, they would likely be out of the market. Instead, trading volumes have held up well despite the fact that we've been in an 11-month-long bear market. We see similar anomalies when we compare attitudinal economic data like, say, for example, consumer sentiment to behavioral data like consumer spending or retail sales. Consumers like to feel gloomy, and they complain all the time about inflation, but yet they're still shopping, they're still eating out, and they're still taking vacations.

And, secondly, I think it's important to recognize that very few of our clients are traders only. In other words, most investors are long-term investors. It's just that some of them are traders, too. My recommendation has always been to carve out no more than 20% of your portfolio for trading. The rest should always be long-term focused. So while we classify these clients as traders, they're investors, too, and that means the opportunities they see may not all be trading opportunities.

In the past few months, I've been traveling quite a bit and I've done several in-person events in places like New York, Southern California, all around the San Francisco Bay Area, Seattle, Minneapolis, and most of these clients I've spoken to seem to have a very pragmatic perspective on the markets at the moment. You know, they aren't particularly thrilled about the current bear market that we're in, but they also recognize that years like 2021, for example, don't come along all that often, and the current environment is nothing like the 2008 financial crisis.

Now, this has been a very mild bear market from a historical perspective. Obviously, things could deteriorate further, but with the current bottom that was reached back in mid-October, this has been the shallowest bear market actually since 1966. Also, experienced traders don't need the market to go up to find opportunities. They just need some volatility. And, frankly, we've had plenty of that this year. Among those clients who trade actively, many have told me that they've used the downturn to accumulate shares in high-quality names. Many of them have also told me that they've had good success doing things like selling calls and put options this year because, frankly, the premiums have been driven higher by market volatility. To that point, the 2022 year-to-date average for the CBOE Volatility Index, known as the VIX, which is a forward-looking volatility forecast based on option prices, has been almost 26. And yet this is the only bear market in the last 30 years since the VIX was created in which it hasn't spiked above 40, or at least not yet. Others have told me that they've found opportunities in fixed-income products probably for the first time in over a decade.

And a final point worth recognizing is that trading commissions are now free, and that means investors can buy and sell even very small lots without worrying about trade costs. This factor has also contributed to sustained high trading volumes. From a cost perspective, there has never been a better time to be a retail investor. Everyone loves a good sale, and, right now, the entire S&P 500 is 15% off.

MIKE: Well, Randy, that's a great way to end this whirlwind tour of the markets. Thanks to Randy Frederick, managing director for trading and derivatives, as well as Kathy Jones, Liz Ann Sonders, and Jeff Kleintop, for making the time to talk with me today.

Well, that's all for this week's episode of WashingtonWise, and that's a wrap for our podcast for 2022. We'll be back with new episodes in January, so take a moment now to follow this show in your listening app, so you won't miss an episode. And if you like what you've heard, leave us a rating or a review. That really helps new listeners discover the show.

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

Most importantly, thanks to the incredible team that has worked so hard behind the scenes this year to make this podcast possible, Gay Matthes, Patrick Ricci, Pete Knezevich, Deborah Hinton-Brown, Lindsey Martin, and Adam Bromberg.

I'm Mike Townsend, and this has been WashingtonWise, a podcast for investors. Happy holidays to all, and keep investing wisely.