MIKE TOWNSEND: Like a lot of investors, I try to be aware of what's going on, broadly speaking, in the economy. I get alerts on my phone when the jobs report comes out or the latest inflation data, and I can toss around phrases like "non-farm payrolls" and "dot-plot" and "housing starts" and "quantitative tightening" with the best of them. But I have to admit that I'm actually pretty terrible at making sense of all the information. Economics is filled with inscrutable lingo and acronyms. For example, the Consumer Price Index, generally called the CPI, is the inflation measure that is probably best known, but the Personal Consumption Expenditures Index, or PCE, is the inflation measure the Federal Reserve prefers, yet I think most investors just think about inflation as a single number. And it feels like economists are always revising their data after the fact, which can be confusing. This is often buried deep within the latest report, where we'll learn that actually last month's jobs numbers weren't as good as we thought, which then changes how we interpret this month's jobs numbers.
Another issue is how economic data is presented to the public. I think it's in our nature to focus on just one big takeaway when faced with a lot of information. The unemployment rate, for example, simple number, easy to understand, it's either up or it's down, but of course the details underneath that top line number really matter. We're in an environment right now where it feels like the big numbers are in a pretty good place. Inflation is coming down. Unemployment is still relatively low. The S&P 500® is up double digits year-to-date. So then why is there this persistent undercurrent of concern that trouble is lurking beneath those numbers?
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's really worth paying attention to.
In just a few minutes, I'm going to welcome back to the podcast Kevin Gordon, director and senior investment strategist with the Schwab Center for Financial Research. I'll be talking with Kevin about some of the recent economic data—inflation, jobs report, consumer confidence, and what is happening beneath the surface of the headline numbers. How should investors be sorting through it all? What will the Federal Reserve make of this data? And what does it mean for investors in the markets as we head into the second half of the year? But first, here are three things to know about what's going on in Washington right now.
This week, I wanted to start with the Supreme Court, which just wrapped up its term with a blizzard of decisions over the final few days. While much of the attention is focused on the court's decision on presidential immunity, our show is focused on the intersection between policy and finance. So I want to take a closer look at another decision that could have significant ramifications for investors in the medium to longer term.
On June 28, a divided court tossed out something called the Chevron Doctrine. This was a standard that had been in place since 1984, and what it said was that whenever a law passed by Congress was unclear or vague, then the courts had to defer to the expertise of the regulatory agencies in interpreting that law through regulations as long as those regulations were reasonable. When the original case was decided 40 years ago, it was not seen as a particularly significant ruling, but it became a major precedent in cases involving decisions made by regulatory agencies, and it's been cited in more than 18,000 cases since. The new decision throws that standard out and says that courts must "exercise their independent judgment in deciding whether an agency has acted within its statutory authority when writing rules." It takes a lot of power away from regulatory agencies and puts it in the courts.
The decision has staggering implications for the regulatory environment across every sector—healthcare; technology, including artificial intelligence; climate and the environment; endangered species; and of course the financial sector. It will make the courts the ultimate arbiter of what regulations should stay in place, and it will make legal challenges against new and existing regulations much easier and likely much more frequent. It may also require Congress in the future to write laws that are extremely specific and detailed, giving regulatory agencies clear direction about what the rules should be.
Opponents of this decision argue that it ignores the technical and scientific expertise at regulatory agencies and will require judges to make decisions on matters that they may not have the expertise for. They also argued that it will lead to wildly different interpretations of the law, depending on the perspective of the particular judge in a case, which, in turn, will lead to inconsistent decisions. And they argue it will clog the courts, delaying decisions and creating a backlog that means court cases of all types will take longer to be resolved.
Proponents argue that the Chevron standard took power away from the judges and put it in the hands of the executive branch, creating what is often referred to as the administrative state.
It's going to take years for all this to get sorted out, but in the immediate term, it could have a direct impact on several recent rules and rule proposals. The SEC's Climate Risk Disclosure Rule that was approved in March and is currently facing eight legal challenges seemed already in danger of being struck down. The Supreme Court decision may make that even more likely. The decision could also impact several rules that are in the queue at the SEC, including a series of proposals to overhaul equity market structure that were first proposed in late 2022, a proposed rule governing the use of technology and investment advice interactions, one dealing with liquidity in mutual funds, and many more.
I don't think it's hyperbole to say this will have a profound effect in the coming years on the regulatory environment across every sector. A lot of rules are going to be challenged in the courts, a lengthy and time-consuming process that could produce a period of uncertainty for companies that are subject to a wide variety of regulations.
Second, there was an interesting legislative development just prior to the July 4 congressional recess. Earlier this year, a bipartisan bill that would set federal privacy standards was unveiled. It attracted a lot of attention because it was co-authored by the Republican chair of the House Energy and Commerce Committee, Congresswoman Kathy McMorris Rodgers of Washington state, and the Democratic chair of the Senate Commerce Committee, Senator Maria Cantwell, also of Washington state. It had the support of the House panel's top Democrat as well. Congress has long struggled to craft a federal privacy law, leading to a situation where there is a patchwork quilt of state privacy laws, but no one overarching set of federal standards to help people protect their data and information. The bipartisan bill that was announced in April, known as the American Privacy Rights Act, is unusual, as it is rare these days to have key leaders from opposite parties in the Senate and the House working together. One key compromise was that the bill would pre-empt state laws―that's a top priority for Republicans―while preserving the right of consumers to sue for damages, which is a major priority for Democrats. As it turned out, that compromise didn't sit well with everyone, and there were many other details that raised concerns on both sides of the aisle. Just before the July 4 recess, a planned meeting of the House committee to consider, amend, and potentially vote on the legislation, which is the last step before a bill can go to the House floor for a vote was canceled just minutes before it was to begin. Republican leaders in the House voiced strong public concerns with the bill, undercutting the Republican chair of the committee of jurisdiction and splitting the party on the issue.
Privacy rights are incredibly complex and controversial, and attempts to craft a federal law have failed multiple times in recent years. This latest attempt was briefly hailed as a major breakthrough, but now it too has fallen victim, at least at the moment, to the divided Congress. And it underscores just how difficult it is for Congress to grapple with big, complex issues. Next year, we'll see very complex issues, like taxes and the debt ceiling, on the agenda. Other thorny issues like Social Security and reducing the federal deficit are also looming. How Congress will solve these given the deep divisions on Capitol Hill is anyone's guess.
Finally, I can't ignore what is obviously the biggest political issue going on right now, the question of whether President Biden might decide not to run for a second term. Polls have been consistent for more than a year in showing that the biggest concern of voters about President Biden is his age, and whether he's physically and mentally up for the rigors of running for president and being president for the next four years. His shaky performance in the first presidential debate on June 27 made those questions the central issue of the campaign right now. Ultimately, it's President Biden's decision and his alone. He's accumulated an overwhelming number of delegates. He is the nominee until he chooses not to be. But this is an unprecedented situation in modern politics. In 1968, President Lyndon B. Johnson surprised the nation in March, announcing that he would not run for re-election that fall. That's perhaps the closest correlation, but circumstances were vastly different then.
Here in 2024, there is still time. The Democratic National Convention does not start until August 19. If the president were to decide not to run between now and then, he could release the delegates that are pledged to him. Those delegates would then be free to vote for another candidate at the convention. The president can and likely would ask that his delegates support a candidate of his choosing, like Vice President Kamala Harris, but delegates would not be bound to do so.
Practically speaking, it's very hard to see the Democrats having a truly open or brokered convention in August, some kind of wild free for all with multiple candidates. It's more likely that the party would try to build consensus around a new nominee in advance of the convention, but all this is pure speculation unless the president changes his mind about running again. It's one more incredible situation in what continues to be a wild runup to the election.
On my deeper dive today, I want to take a closer look at what's going on in the economy, the implications for the Fed and potential rate cuts, and how the markets are reacting. I'm really pleased to welcome back to the podcast Kevin Gordon, director and senior investment strategist with the Schwab Center for Financial Research. Welcome back, Kevin. Thanks so much for taking the time to talk to me today.
KEVIN GORDON: Hey, Mike, great to be back with you. Thanks for having me.
MIKE: Well, Kevin, let's start with the economy. We've had a flurry of data in the last couple of weeks, and I'd love for you to help explain what's important. The Fed's preferred inflation measure is the Personal Consumption Expenditures Index, better known as the PCE. So let's start there. What is the PCE, why does the Fed prefer it, and what was your takeaway from this most recent report?
KEVIN: Well, I think if we look broadly, first at the economic data, the message that we're getting over the past few weeks is that economic growth continues to slow, but it's not at an alarming rate. So even though we just wrapped up the second quarter of the year, I do want to highlight the final data release that we got for first-quarter gross domestic product growth. We just call it GDP growth. And as a reminder, GDP data goes through a couple of revisions. So the initial report is rarely telling the whole story. And if you look at growth for the first quarter throughout this revision cycle, it was revised slightly lower, just 0.2% from the initial read. What was more interesting to me is that if you look at the personal consumption data, which we also call consumer spending, that was revised down by a full percentage point. And almost all of that was driven by a reduction in spending on goods, not as much on services, which stayed relatively strong. But if you look at that slowdown in spending, that full percentage point decline, that basically tells us that there was less momentum heading into the second quarter than we originally thought. And that kind of deceleration might seem worrisome, but I think we have to keep in mind that this is mostly what the Fed is looking for in order to get inflation back down towards their target.
So all else equal, a slowdown in spending, coupled with a labor market that stays relatively resilient that'll help bring inflation back down towards their 2% target. And for the most part, you're continuing to see that. And we've seen this string of friendlier inflation data lately, most recently, the PCE data that we got for May. And as you mentioned, the PCE is the one that the Fed focuses on mostly. And if you look at the year-over-year changes in both headline PCE and core PCE, which strips out food and energy, they were both 2.6% as of May.
The good news is that those rates continue to prove that we've made a lot of progress, and we're making a lot of progress, since the peak in inflation. The concern is that we're still waiting to confirm that the reacceleration that we saw in the first quarter of this year was just a head fake. Even if that turns out to be the case, I think that we'll need a couple of more months of inflation reports that look like the one that we saw in May to convince the Fed that we are, in fact, on a sustainable path to their 2% target.
And to your last point, the Federal Open Market Committee's preference for a 2% target on the PCE mostly boils down to, I think, how much data is captured by the PCE itself. So if you look at something like the Consumer Price Index, or the CPI, that only covers urban spending. The PCE includes a broader swath of both rural and urban spending. The PCE also is quicker to adapt to changes in spending habits of consumers. So, you know, one could argue that it's a bit more accurate in capturing these faster changes when we have them in consumption patterns.
MIKE: So pretty good news on the inflation front. We also saw consumer sentiment fall in June, but by less than expected. And, you know, I always find it fascinating when the headlines are essentially, "Well, people see things as a little less bad." So what do you make of consumer sentiment right now? Do people see the glass as half empty or half full? And is that something that factors into the market at all?
KEVIN: Well, the first distinction that we have to make is between consumer sentiment and consumer confidence, especially as it pertains to where these data points are coming from. So if you look at something like the Consumer Sentiment Index, also known as the CSI, it's put out by the University of Michigan, versus something like the Consumer Confidence Index, or the CCI, which is put out by the Conference Board, they're telling different stories. So first of all, the Consumer Sentiment Index, that's driven more by inflation. So it's probably not surprising then when you look at a chart of it over the past several years, you'd see that the index tanked as inflation surged, and the pace at which sentiment fell was consistent with prior recessions. And it's one of the reasons, many reasons, that economists started to forecast a recession starting in 2023.
But if you looked at the other side, if you looked at CCI, the one put out by the Conference Board, while you did, in fact, see a dip, it was nowhere near as severe as the one that we saw in the CSI. And that's because despite the fact that we had this huge surge in inflation, there was no mass layoff cycle that hit the labor market, and as was confirmed by last Friday's jobs report, we've continued to see the economy add hundreds of thousands of jobs each month for the past several years.
MIKE: Well, that's a really helpful distinction. So what does the difference between the sentiment measure and the confidence measure tell you?
KEVIN: I think the divergence between these indexes confirms that even if the labor market is strong, it won't necessarily stop consumers from saying that things are not going well, given the level of their adverse reaction to the inflation backdrop. And I think that's been the main driver of pessimism in both the consumer and the business world over the past couple of years.
And it's interesting because you and I, you know, the analyst and the strategist community, we're laser focused on month-over-month and year-over-year changes in inflation. But the reality is that the general public is focused on the change in price levels. And with this large shift that we've seen since the pandemic started, we're still going through this adjustment in this digestion process. And I'm not exactly sure when that will fully play out, mostly because we haven't seen this kind of level shift in quite some time. And even though there were some similarities in the 1970s and the 1980s, the country and the world looked different back then. So the comparison is not necessarily apples to apples.
MIKE: Well, the other big data point that we've gotten recently is the latest jobs report, which was kind of another mixed bag. It seems that's been the case for a while now. So what do we take away from the state of the labor market?
KEVIN: Well, you're right to point out it's been a mixed bag because, depending on which labor data you look at, you'll get a completely different view of the economy, and frankly, you'll get conflicting views as to whether we're in a mid-cycle expansion, or we're in a late-cycle slowdown, or even a recession. So if you start with the big picture numbers, the U.S. economy added 206,000 jobs in June. That was stronger than what the consensus of economists polled by Bloomberg we're expecting, which was 190,000. You had the unemployment rate move up slightly, from 4% to 4.1%. Average hourly earnings increased by 3.9% year-over-year, which was down from 4.1% in May. And then, finally, you had the labor force participation rate go up to 62.6%, which was up from 62.5% in May.
So overall, that batch of statistics that I just laid out, that was a good report on the surface. But as you know, and we've talked about these days, you really have to look below the surface to see some of the more notable cracks in the foundation. And as it pertains to payrolls, even though we created 206,000 jobs in June, the gains in April and May were revised lower by 111,000 jobs. Plus, even in June, nearly three-quarters of the payroll gains that we saw were in health and education and the government sectors. So if you look at others that are more cyclical in nature, things like manufacturing that are more tied to the economic cycle, we actually saw hiring stall out or actually in some cases decline. And as it pertains to the unemployment rate, it is true that if you look at the current rate of 4.1%, it is pretty low relative to history. However, over the past year it's been steadily moving higher, and, in fact, it's above its rolling three-year average. And whenever that's happened in history, it's been a consistent recession signal.
So many economists and investors have pointed specifically to that increase as this surefire sign that we actually are already in a recession. But the caveat there is that there are several data points that still fail to support that claim. Plus, we have to be mindful of how unique the cycle has been, and of the fact that many indicators have failed to act as a useful recession warning this time around. It doesn't necessarily mean we shouldn't pay attention to the increase in unemployment, but we do need to consider the fact that much of its increase lately has been due to an expansion of the labor force, not necessarily this massive decline in employment. And if you've got a larger pool of individuals looking for jobs, you just mathematically have an unemployment rate that moves higher.
That said, I think there are cracks worth noting, especially within something that's called the household survey, which is different from the establishment survey that measures overall payroll growth, which I was mentioning earlier. So the household survey is different because it's a survey of households, it's a survey of individuals, that simply asks if they're working. And it's been much weaker than the payroll data over the past couple of years. And what's interesting is that it captures full- and part-time employment. And interestingly, full-time employment has actually been contracting at a year-over-year pace, and that's consistent with prior recessions.
The unfortunate caveat with this, though, is that the household survey, it captures a smaller sample size than the establishment survey, and it's also much more volatile. So it's hard to take any kind of signal from one given month of data. And that's why we're keeping an eye on all these cracks, especially the fact that, you know, revisions are still running negative, the unemployment rate is drifting higher, and you've got this contraction in full-time employment. But I do want to point out, again, this is broadly consistent with what the Fed's goal of seeing the labor market loosen up as inflation eases. The good news so far is that the labor market is not experiencing some swift deterioration.
MIKE: OK, so we've talked inflation numbers, consumer confidence, jobs numbers. I guess the big question is how does all this work together to impact the outlook for Fed rate cuts? What else is the Fed going to need to see?
KEVIN: So we're increasingly moving into the camp that this continued softness in the labor market, if it persists, will probably be a factor or the factor that drives the Fed to cut rates. And if we continue to see the disinflation trend gain momentum, you have growth that continues to slow, and then you've got the unemployment rate drift higher, I definitely see the case for a rate cut either in September or November. July is probably off the table, since the Fed wants more data to, number one, confirm that the labor market is, in fact, slowing more; and then number two, gain more confidence that the reacceleration in inflation earlier this year was just, in fact, a blip.
What's more interesting to me, however, is how the Fed, and Powell, in particular, communicate the next rate cutting cycle. We know by virtually any metric, monetary policy is in a restrictive stance right now. So the amount of easing that we're likely to see from here won't really deliver any kind of major stimulus to the economy if it's just a rate cut or two. It will just take some of that restrictiveness down a couple of notches. Plus, I think it's really key to think about the nature of this Fed cutting cycle, and that to me is more important for the market, as opposed to the fact that we're just so focused on the Fed, when they cut rates and how much it is for the first rate cut. We know that they're not keen on repeating what has happened in prior tightening cycles, especially the past few where they've cut aggressively to zero. They tried that experiment, particularly after the global financial crisis, didn't really get the outcome that they were looking for, and it didn't work out necessarily well.
So it seems plausible that they'll engage in a less aggressive cycle this time, you know, barring some sort of major crisis, but no one really knows how much the Fed is going to cut by. The members themselves don't even know.
So I think we got to take it back to the party line, and forgive me for saying it here, but the rate path is really just going to depend on the data itself. If the trends in consumption that I mentioned earlier continue, and you see the labor markets soften even more from here, that'll help put downward pressure on inflation. So even if we're still, you know, a bit of a distance from their 2% target, we'll have to see how convinced the Fed members are that the forces I mentioned eventually result in reduced inflation pressures and then ultimately something that pushes them to cut.
MIKE: Well, really helpful insights on what the Fed is thinking about and how the stock market may react. And I want to shift now to the market. The first half of 2024 is in the rear-view mirror. We saw the S&P 500 up about 15% in the first half of the year. Nasdaq Composite up about 20%. So as an investor, pretty hard to argue with that kind of performance. But similar to some of the comments you just made about the jobs numbers, you've been talking a lot about the churn beneath the surface. So what are you watching? Should investors be concerned?
KEVIN: Yeah, so when Liz Ann and I put together our mid-year outlook for this year a few weeks ago, we focused on this theme of bifurcations in both the economy and the stock market. So if you look within the economy, there's this theme that's developing between strength and weakness. So if you think about the spread between confidence for higher-income consumers, stronger, versus lower-income consumers, weaker. Similar dynamic with nominal income being stronger and inflation-adjusted income being weaker, or inflation for discretionary items versus non-discretionary items. For the latter camp, it's still really sticky. That's just to name a few on the economic side.
Within the market, there are some worrying bifurcations that started to emerge as we moved throughout the first half of the year, and one of those was this continued strength at the market index level, yet waning strength at the individual member level. So just to put an example out there, if you look at the S&P 500, you know, it made more than 30 new all-time highs in the first half of the year. That's undoubtedly a good thing. But it's important to note that at the start of the year, 92% of its members were trading above their 50-day moving average. By the time you got to the end of the first half, that share had fallen to 49%. And if you look at it another way, the largest pullback that we had for the S&P in the first half of the year was 5.5%, and that's not steep at all, but if you look at the average maximum drawdown at the individual member level, it was down 15%. That's well into correction territory. And it's much starker at the small-cap level. So the worst drawdown that we've seen for the Russell 2000 this year and in the first half was slightly less than 10%, so not quite yet at correction territory if you want to get really technical, but the average max drawdown at the individual member level is nearly 30%. That's well into bear market territory.
So it all kind of leads to this illustration, or the way that, you know, we've been describing the market this year, which is that if at the beginning of the year there was a strategist who came to you and said, "I think the market is going to do super well in the first half. We're going to rip by 15%. We're going to have several new highs." And then another strategist came to you and said, "I think the market is really going to struggle, and we're going to undergo a correction." Both would be correct. It just depends on which market and which part of the market you want to focus on.
And so I think that with those kinds of bifurcations, we need to just be increasingly on the lookout for any continued weakness under the surface if the indexes continue to make new highs as you get this weakness below the surface. And that's essentially what happened in the back half of 2021. It turned out to be a great year for the indexes, but as the year progressed, there was a notable deterioration in breadth by the time the year concluded. And that was a near perfect setup for the bear market that started in January of 2022. I think it's too soon to say that we're facing a similar fate this time, but given that we're also in this frothy investor sentiment environment again, I think we just have to be on guard. You know, the backdrop has gotten increasingly fragile, especially since the largest names in the market are now the most highly correlated with momentum, and that tends to feed on itself over time.
MIKE: Yeah, and talking about those largest names, I think we've heard throughout the first half of this year that the market feels like it's been driven by just a handful of mega-cap stocks. Now, we've seen some recent pullbacks from Nvidia and other big names. So are we seeing investors take profits and maybe rotate that money into other sectors? And if so, I mean that's got to be a good thing for the overall health of the market, right?
KEVIN: Yeah, it wouldn't surprise me if they're taking profits. But I think at the same time it doesn't seem like they're rotating aggressively into other sectors so far. And as an example, since Nvidia's most recent peak in mid-June, the two best performing sectors have been communication services and consumer discretionary. You know, those sectors don't house Nvidia, but they do house the other mega-cap stocks, like Alphabet or Meta, Tesla or Amazon. And that said, I will point out that we've seen other sectors, like energy and financials, actually pull ahead of tech over that same timeframe. So there's been a minor rotation, but it's still early days. And it's hard to say that it's durable right now because you still have four sectors that are down since mid-June.
But I agree with you, I think that if this continues, it would ultimately be a healthy sign. And that's especially true given the weaker-breadth environment we've been in. You know, we really are approaching this more critical juncture where the lagging sectors do need to come up for some air. And if that isn't the case, I think that top heaviness of the market will become a greater risk, where you have this risk of the indexes, you know, supposedly catching down to what's been going on at the member level, as opposed to the rest of the market catching up.
And, you know, one important consideration is the fact that I don't think we necessarily need to see this outright decline in some of the mega-caps for the rest of the market to do well. I saw that a lot as a base case from several analysts and strategists at the beginning of this year, but a broadening out in the rally doesn't have to be a zero-sum game.
So I think that given the economic data are not yet signaling a recession is imminent, the Fed has room to cut rates, and earnings are still expanding, there still is support for the rest of the market to regain its footing. It may not happen immediately or imminently, but that's part of the good news. These performance discrepancies often breed opportunities for sectors that have lagged behind.
MIKE: Well, Kevin, you and I both travel around the country. We talk with investors about what's going on in the markets. I talk more about policy, politics, the election, and the intersection with the markets. It's a bit different than your talks with investors, more about the economy and what's going on inside the markets. But what I'm struck by, and I'm guessing you are hearing this too, is that despite the strong positive performance over the first half of the year, there's just a lot of angst among investors. It's like they don't really believe in what they're seeing from the market or at least aren't convinced it can continue into the second half of the year. Is that what you are hearing? And what do you think is causing that disconnect?
KEVIN: Well, just to put some more color around what you said, the most striking thing I've seen so far this year is that Harris Poll that was done in mid-May for The Guardian, in which 49% of respondents said that they believed the S&P 500 was down for the year, which is just absolutely wild considering the fact that by the time that poll was conducted, the S&P 500 was up by nearly 10% this year. Not to mention the fact that it was up by 24% in 2023.
And the other striking statistic on the economic side was the fact that 49% of respondents also believed the unemployment rate was at a 50-year high, which, again, it's just wild, considering that at the time the unemployment rate was 3.9%.
MIKE: Yeah, I've been using those statistics in my client events as well. Absolutely mind boggling. So what do you think explains this kind of disconnect?
KEVIN: So I think there are a couple things that help explain it, chief among them just the notion that misinformation spreads really fast these days. I see it myself. I'm sure you do too because you're on social media and financial media. But it's just quite staggering as to how many inaccurate statistics float around in both spheres.
The other factor at play, perhaps not surprisingly, is the inflation backdrop. And I really think that this broader consumer base has been stung so much by this huge level shift that we've seen in prices over the past few years, that it's been enough to make them think that the economy is performing poorly. And we're sort of learning this in real time. I'm generalizing a bit, but consumers seem to hate inflation much more than they love a fully employed labor market. And it's one of the reasons that I think time will simply be the main antidote for healing the issue we face today with inflation and with general sentiment, you know, otherwise known as "the vibes." But there are many consumers who are wishing for prices to go down, and they think that that's the thing that's going to be the solution. But there's two issues with that.
I would say primarily, prices go up over time. If you look at any long-term chart of the CPI or the PCE index, or any inflation index, you'll see that these are not mean-reverting series. They increase as time goes on. It's a sign of a healthy economy. Sometimes we have faster increases, like we've all experienced since the pandemic. Sometimes, though rarely, prices retreat from a high, but they don't go back to where they were before.
And that brings me to the second point, which is that if you're still wishing for outright price declines, or deflation, broadly across the economy, that's dangerous, since those are typically associated with recessions. Logically, if you think about it, it makes sense to see a deflation in a downturn because the labor market goes into contraction, individuals lose their jobs and income, and then they cannot spend money. So firms are essentially forced to cut prices. No one likes to hear that they simply have to wait it out to get over an inflation issue, but I think we also have to think about the alternatives. If you have this broad-based double-digit increase in wages, that's pretty unrealistic across the board. If you have a broad-based double-digit decline in inflation indexes, that would be disastrous for the economy.
MIKE: Yeah, Kevin, I think you've absolutely hit it on the head with that last thought about the difference between inflation coming down and prices coming down. I think people say, "Oh, inflation's coming down, therefore I should see the prices drop on the shelf," whether that's milk or gas, or whatever the product is. And of course that's not typically true, and I do think that's a big source of the pessimism that sort of lingers out there.
But let's close on a more optimistic note. What are some of the positives that you see that maybe average investors are not factoring in yet, and what do investors need to watch out for?
KEVIN: Well, to my earlier point about market breadth and how this environment tends to breed opportunities for areas of the market that haven't caught up, I do think that as long as we stay in a relatively healthy economic environment, there will be more opportunity for performance to broaden. And I also think this is a great time to revisit the beauty of diversification, especially given the highfliers, particularly in the tech and the tech-related worlds have soared so much. And many investors I think are likely sitting on massive gains and with a lot more exposure to those areas or individual names than they originally planned for or targeted. So I don't see much trouble in rewarding yourself by taking some profits and making sure your diversification goal is met.
And another thing I'm long-term optimistic on, this is more on the economic side, is the fact that even though inflation has been more of an issue this cycle, we're seeing wage gains, finally, for the largest chunk of the labor market, material wage gains, the non-supervisory workforce, which is a group that really struggled to see any meaningful wage growth in the expansion that followed the global financial crisis. This has been a huge win for them. And now that inflation has rolled over, real wage growth is positive again.
So even though we're seeing some labor cracks, and folks are still generally upset with inflation dynamics that we're facing today, I think it's a major positive that we've gone through 525 basis points of tightening from the Fed and close to a round-trip in the year-over-year change in inflation, and yet we continue to see hundreds of thousands of jobs added per month. And of course, we need to be on the lookout for the wider cracks down the line that I mentioned, especially now that the Fed has been on hold for nearly a year. But as the cycle has proven to us time and again, no one can perfectly forecast what's going to happen. So I think we just have to be humble with the data, and more importantly, keep our convictions relatively low.
MIKE: Well, great perspective as always, Kevin. I really appreciate you taking the time to be on the show with me today.
KEVIN: Thanks, Mike. Always a pleasure.
MIKE: That's Kevin Gordon, director and senior investment strategist here at Schwab. He is a must follow on X, formerly known as Twitter, especially if you like charts, because Kevin shares a lot of charts. You can find him @KevRGordon.
Well, that's all for this week's episode of WashingtonWise. We'll be back with a new episode in two weeks when we'll be focusing on Social Security. Take a moment now to follow the show on your listening app, so you get an alert when that episode drops, and you don't miss any future episodes. And I would be so grateful if you would take just a minute to leave us a rating or a review. Those really help new listeners discover the show. For important disclosures, see the show notes or schwab.com/WashingtonWise, where you can also find a transcript. I'm Mike Townsend, and this has been WashingtonWise, a podcast for investors. Wherever you are, stay safe, stay healthy, and keep investing wisely.
