7 Charts For Client Conversations In Q4 2026: Interest Rates, The Fed, AI, And More

Title: Putting Economic And Q3 Market Headlines Into Context For Clients

Shownotes:

• James Liu: LinkedIn | Website

Full Transcript:

Adam: Hello, and welcome back to the "Financial Advisor Technician" podcast. I'm your host, Adam Van Deusen. On today's episode, we're going to discuss the current market environment and how advisors can address common client concerns. Because while clients might be investing for the long term, it's hard for them to miss the latest financial headlines, from rising bond yields and interest rates to elevated oil prices, which offers advisors the opportunity to demonstrate their expertise, build client confidence, and ultimately help clients stay on track to meet their investment goals by being prepared to address these questions and put the latest macroeconomic activity into context.

To help us dig deeper into this topic, I'm joined today by James Liu, the founder and CEO of advisor data and insights company Clearnomics, to discuss the key issues that drove market performance during the recently ended third quarter and what events could move the market in Q4. So welcome, James, and thanks for joining us here on the Financial Advisor Technician podcast.

James: Adam, thanks for having me.

Rising Bond Yields And What They Mean For Client Portfolios [1:15]

Adam: So, to start, a major issue this quarter was the continuing rise in bond yields. Perhaps you could start by putting the current state of bond yields into historical context and maybe discuss what this means for financial planning clients in practical terms.

James: Well, Adam, that's a great point on bond yields. And what happened in the third quarter could really play out again in the fourth quarter. And so, what we're seeing today for those advisors who may have seen headlines but haven't dug deep into it is a complete reversal of the rate environment that we've seen over the last 20 years.

So, for example, over the last 15 years, we've had interest rates that have been exceptionally low. And that only reversed after the pandemic, when we had high inflation and the Fed pushing rates higher. And what we've seen over the last year or so is that those rates have not only stayed high, but they've gone higher from there.

So, today, whether you're talking about the five-year yield, the 10-year, the 30-year Treasury, all of those yields are near 20-year highs. We can talk about the specific factors driving those. There are several of those that we'll get into, I'm sure, in a few minutes. But I think the ultimate point for advisors when they work with their clients is that the playbook for dealing with an ultra-low environment after 2008 is very different from what we're seeing today.

And so, what factors are driving those rates higher? Well, it's oil and inflation, especially with the war in Iran continuing. It's the fact that the Fed is now hiking rates. And that's something we haven't seen in about three years. It's the fact that we have steady economic growth. And it's also concerns around the national debt and the federal deficit.

So all these different themes, there are themes happening in the background here in the markets. They're things that clients are seeing headlines around. But I think it's important to help put all that in perspective so that clients can really understand what's driving these rates higher in the headlines that they're seeing every day.

Adam: And then, I guess thinking of the historical context, as you mentioned, it's been quite a long time since we've seen yields this high. But looking at the broader, maybe decades term, where do the current bond yields sort of sit in this context?

James: So bond yields are near multi-decade highs right now. These are yields that were very common in the 1990s and the very early 2000s before the 2008 global financial crisis. But since then, these yields basically are much higher than what we saw after that period. And so, when investors think about this, it doesn't just affect markets. It affects all aspects of their financial lives.

So when you think about interest rates, not only do interest rates reflect what's happening in the economy and the financial system, but they then feed back into the system as well. So, for example, if you think about household balance sheets, not only does it affect the liability side with interest rates on personal loans, credit cards. Right now, the 30-year mortgage rate is around seven percent, but it also affects the asset side as well with savings rates, cash yields, and how you want to allocate to that bond portfolio.

So, if we think about this year, for instance, what you have is a situation where you have stocks near all-time highs. Now, normally, you would think that interest rates being high would be bad for stocks, but that's because interest rates aren't just high because of inflation as they were in, say, 2022. Interest rates are also high because the economy is doing quite well.

So that's helped to push the stock market higher. But, on the other hand, because interest rates are high, of course, you have bond prices coming down as well. So, when you look at large aggregate bond indexes like the Bloomberg aggregate, you have the overall return being flat to negative so far this year.

So when it goes to looking at portfolios, for instance, what you have to consider is the fact that you have equities doing extremely well. You have bonds which have helped to stabilize portfolios, especially during periods of geopolitical turmoil, but you may not get that return boost that you've seen really over the last 40 years in bonds. And instead, you have an opportunity where bonds can help provide that extra boost of income with rates at these levels.

Adam: Yeah. That's a really interesting point because the experience that clients might have had so far, if they're looking at their portfolio statement, is, as you mentioned, might be flat to, perhaps, a little bit down, depending on what they're invested in. But I think from an advisor's perspective, they're looking at going forward with the higher yields, more income generated.

And I would also imagine, you mentioned the bonds as a buffer, if we ever did have an economic downturn, that gives the bonds a little bit more cushion for bond prices to rise with yields potentially falling in an economic downturn. Whereas if you go back a few years, bonds are at one percent, two percent, something like that, there just wasn't really much room.

The Fed’s Recent Rate Hike And Inflation [5:55]

Adam: So moving on to another topic, you mentioned the Fed's actions before. And recently, we saw the first Fed rate hike recently. Perhaps you could talk about, what is the Fed looking at? What are they reacting to, and how might that affect the market moving towards the end of the year?

James: Well, it's not unusual at all for investors and the market to have their eyes focused on the Fed. But I think it does matter. And it's important to distinguish why the Fed is raising rates. There are situations, let's say back in 2022, so only just a few years ago, where there was this view that the Fed was behind the curve, that there was inflation that was rapidly rising after the pandemic and the Fed was too slow in hiking rates to control it. And I think the important thing to say is that that is really not the situation today. And that is also not how the market views it today.

So, again, if you go back to 2022, you had two different sources of inflation. You had the supply-side disruption because of the pandemic. So that was pushing things like semiconductor prices higher. You also had the invasion of Ukraine by Russia, which pushed oil prices higher. So this double effect on the supply side, which caused inflation.

At the same time, you also had what we call demand-side inflation, which is that there were, of course, all these stimulus checks. There was low interest rates. All of that was propelling the demand side higher as well. So you effectively had this perfect storm that was causing inflation to rapidly affect all parts of the financial system. And the Fed had to jack up rates very quickly.

Now, if you fast-forward to where we are today, that is really not the case. So we have steady economic growth. That's for certain. But, at the same time, you have higher oil prices, but they've been high in a way that's been fairly stable, and the market has been able to adjust to.

And so, the Fed, what's strange is that they would normally be viewed as looking past the high oil price situation because these supply shocks, as we call them, usually economists think of them as temporary. So, we just have to kind of get past this hump in inflation, and everything after that will generally be okay for the economy.

What the Fed is trying to do right now is, well, let's just raise rates a little bit in order to prevent those higher inflation rates from spreading beyond the energy sector into other categories. So that's why the Fed raised rates by 25 basis points in September. That's also why the Fed is expected to raise maybe once more later this year. What we are not seeing in the market or in Fed funds rate expectations is this huge uptick in rate hikes that we saw in 2022.

So the reason to explain all that is because this environment really is different. And so, to the extent there are clients or any investors who are worried about rate hikes because typically rate hikes are seen as being bad for the market and bad for stocks, this is really a different situation that we're in today.

Adam: Very interesting. And there are different inflation measures, sort of the broader CPI measure, but they look at core and super core inflation. Perhaps you could talk about some of the differences in those readings and what they tell about the potential path for prices going forward.

James: Absolutely. I think the key to understand inflation is that, really, economists are just trying to get a gauge of what's happening with prices. And that's different from how we often experience inflation as individuals. So, for us, what matters, and what do we call inflation? Well, it's when you go to the store and egg prices are far higher this week than they were a month ago, or beef or chicken prices, for instance. The everyday necessities that we need. Or if your rent goes up more than you expected this year. Those are the different factors.

So what economists try to measure instead is, well, yes, there are factors that affect specific prices that we all experience, but there is this underlying inflationary trend that is pushing up all prices. And so, what economists try to do is, well, they take a sample or basket of different prices. That's what goes into the consumer price index.

And there's hundreds of different ways you can cut these numbers. For example, right now, you mentioned CPI, for instance. If you take a look at the headline number, the headline number is much higher than most investors and economists would like. The Fed notionally has a two percent target on inflation, and we've been well above that over the past several years. But when you take out energy prices, food prices, and shelter, then what you see is that CPI really is only at two percent.

So, what we're not saying is that food, energy, and shelter are not important and that people don't pay those prices. That's not what we're saying at all. What we are saying is that, well, is there this underlying inflation trend that's pushing all prices higher, and is that beyond categories related to oil prices and the war in Iran? And what the current numbers say is that energy prices are really the reason inflation is higher.

We have oil prices that are still hovering around $100 a barrel, and that has kept energy prices higher, that's pushed gasoline to still around four dollars and 50 cents, on average, per gallon, and that is the underlying driver. And when you look at other categories, yes, inflation may be a little bit higher than we would like, but that's not really what's causing overall inflation and it's not why the Fed is hiking rates today.

Adam: Very interesting. And I should note for our listeners, this has been a great conversation, but if you are perhaps more visually inclined, James has written a wonderful article for the "Nerd's Eye View" blog that includes several charts that might be helpful for you to put these topics into context, but also that might be useful for upcoming client meetings. So, if you're interested in seeing that, you can go to kitces.com/FAT12 to see that article and all of those charts.

Addressing Whether Commodities Belong In Client Portfolios Amidst Elevated Prices [11:48]

Adam: Now, in that last conversation, we were talking a good bit about oil and the effect of oil on the inflation rate. I can see that hitting clients in a few areas, one, of course, at the gas tank as they've been filling up over the last several months, but I'd imagine, when they're talking to their advisors, perhaps saying, hey, commodity prices are up. Is this the time for me to be in commodities? So, I guess, broadly, how do commodities fit within the portfolio? And I would say it's sort of in a historical context, and why might advisors or their clients consider an allocation or not?

James: Well, Adam, as you know, commodities can be a challenging conversation to have with clients, especially those who focus on specific commodities like gold, silver over the past couple of years. So, there are a few key facts to keep in mind here. The first is that commodities, as a broad index, those are the best-performing asset classes so far this year.

And really, when you look across history, one of the charts that you mentioned in that piece looks at different asset classes and how they perform each year. What you see is that commodities are highly, highly volatile. So not just the individual commodities, but as an asset class.

And there are periods where, yes, oil prices spike that year or industrial metals jump, and therefore, you have high returns for that asset class. But there are other years where it's the worst-performing asset class. So, of course, ultimately what this comes down to that your audience knows very well is that it's about diversifying across these different asset classes, not just focusing on commodities or U.S. large cap stocks, etc. Now, when we dive into commodities and what they've done over the past year, there are a few different interesting stories. One is just with precious metals.

So one of the key stories last year that ended this last January was that gold and silver had basically skyrocketed to new all-time highs. And this, of course, caught a lot of attention. Now, at this point, where we are today, after the end of the third quarter going to the fourth quarter, you have both of those prices still significantly lower than those all-time highs. And really, that just speaks to how volatile precious metals can be.

I think a lot of advisors know the story of the long-term gold trade, which is that you have these boom-and-bust cycles where, yes, it does very well in inflationary environments up to 1980. Then you have this long, almost 30-year bear market. Then it jumps up again after financial crisis and is basically flat until very recently.

And so, it's just an asset that is very hard to incorporate into portfolios unless it's properly diversified. And it's not just precious metals. You have industrial metals. So copper is one of the focuses right now. Copper is especially important in data centers, which is one of the key themes driving equity returns and earnings.

So you need copper for cooling, for electricity, for wiring in data centers, and that's driven those assets as well. And, of course, we've talked about oil multiple times here. You have the war in Iran, you have the Strait of Hormuz still being effectively closed. You have other geopolitical conflicts in the region affecting the Red Sea and Saudi Arabia and their pipeline. And so, all these different factors are affecting commodities today.

So, ultimately, I think the key client takeaway, without going deep into the weeds on any individual commodity, is that these are highly, highly volatile investments. And the key here is not to just get hung up on gold or silver when they're performing well. It's how can they play a role in the overall portfolio? Are they pro-cyclical? Do they rise when everything else in the portfolio is rising, like equities, which is often the case? Or can they have some sort of diversification effect, which is also possible too?

Adam: Yeah. It seems like, at any point, there's something that's some sort of investment or commodity or otherwise that's flying high. That might get a client's attention. You can't miss the news headlines, oil's up this percent this year. "Oh, should I be in oil?"

So I think that context that you gave about, whether it's oil or other commodities, their volatility is a real important factor to get across to clients, and perhaps a great opportunity to show an image of just what those spikes have looked like over time and perhaps put it in greater context for them that when you see it have a peak or a real spike, that it could have a downturn afterwards. At the same time, perhaps, for some clients, being a part of a diversified portfolio. So, bringing that conversation sort of back to a higher level. So, thanks for those points there.

Strong Earnings Boosting Equity Returns [16:17]

Adam: Now, let's move over to equities, often the largest part of clients' portfolios. So when it comes to equities and equity values, you kind of have two sides. You have the earnings that feed into that, but also valuations. So perhaps you could talk about what we've seen so far this year and in the most recent quarter on both of these in terms of what's driving the positive equity returns that we've experienced.

James: Well, Adam, if I could summarize the third quarter into two factors, one is high interest rates, which we've already discussed. The second is that corporate earnings are exceptionally strong. So, when we look at corporate earnings over the long run, that's really what drives stock markets and stock market valuations. If you overlay earnings per share with the overall S&P, for instance, there are points where they disconnect a bit. But really, you're looking at the same rough pattern.

And that shouldn't be unusual for advisors or long-term investors. We know that when the economy does well, that, hopefully, filters in through to earnings and higher profit margins. And that's ultimately what drives dividends, is what drives valuations higher. It's really what supports investors and those long-term portfolios.

And so, when we look at earnings today, what's exceptional is the fact that on a trailing basis, it looks like we've experienced earnings of roughly 30% growth over the past year, which is absolutely astounding. Compare that to the historical average of around seven or eight percent growth.

So, when we look ahead, many of the Wall Street consensus forecasts right now expect that level of growth to continue. So, over the next year, we're looking at about 20% growth, which, again, is several times higher than what we've seen historically. And on top of that, we're expecting the S&P 500 to hit $400 earnings per share over the next year as well. So, no matter which way you cut it, these are huge numbers.

Now, when you dive into individual sectors, that's where the story gets a bit more nuanced. All sectors are performing well right now. We have earnings growth across all the 11 sectors of the S&P 500. But, of course, it's the information technology and the so-called AI-driven sectors that have benefited the most.

So, whether it's information technology itself, or it's communication services, consumer discretionary, these are sectors that are benefiting from the build-out of data centers and the increased use of digital technologies and automation. And so that's really driving, not only profit margins higher, but revenues, as well as, then, bottom-line earnings.

Now, how does that affect valuations? Because it's also the case that valuations have been quite high for the overall stock market over the last several years. At one point, we were just a couple of points away from the peak valuations that we saw during the dot-com boom. And when you look at valuation, so if you think, for instance, of a price to earnings ratio, yes, those prices in the numerator, those have jumped up double digits this year because we've had double digit returns in most of the major indices, getting them to near all-time highs.

But when you look at that denominator, that earnings number, because they're growing so quickly, and, in fact, growing faster than the overall return of the market, that's helped to keep valuations in check. So, the overall PE ratio for the S&P 500, for instance, has come down a bit from above 20 times forward earnings down to about 19 times.

Now, of course, all of this is uncertain. It doesn't guarantee that the market's going to continue to do well the same way it has over the first three quarters of the year, but it does tell you that earnings growth is helping to provide fundamental support for the overall market, which is, of course, positive news for most investors.

Adam: Very interesting. I think a topic for a lot of advisors over the last couple of years was all the attention being given to the "Mag Seven" stocks, the concentration in there. They were solely responsible for driving returns. But from what it sounds like you're saying, the breadth has improved in terms of sectors seeing improved performance. So, I would imagine that's sort of more supportive of a continued bull environment.

James: Yeah. That's exactly right, Adam. You have seen it broadening out of that performance. Now, the Magnificent Seven and other information technology and communication services stocks are still big drivers of the overall stock market. But, of course, this year, you have some more idiosyncratic and more recent themes.

So the fact that oil prices are high, like we've talked about multiple times now, that's helped to drive the energy sector and energy sector earnings. And so, you have a lot of different themes here that are playing together and they're basically helping to support the overall market. And so, we have shifted, as you mentioned, from a world where it was just seven names versus the 493, to a larger breadth of companies helping to support portfolios today.

Putting Recent AI Into Context For Clients [21:06]

Adam: And you mentioned AI in there. Can't go a day without seeing some sort of AI-related headline, whether it's about advances in technology, IPOs, things like that. How can an advisor put what's going on in the AI world into context for their clients?

James: It's a tricky conversation. And that's because there are just so many ways to talk about AI. There's almost existential headlines around AI right now and what's going to happen next. There's the nature of the technology itself. And then there's the nuts and bolts like the data center buildouts that we talked about earlier.

And so, as an advisor sitting down with a client and trying to navigate all these different avenues of conversation, especially if the client is doing a lot of reading on their own, it can be very challenging. So I think trying to corral that conversation into something bite-sized is really important.

And the key things are this. One is that regardless of what the direction that AI goes in in the future will be, it is the case that data center buildouts and the infrastructure aspect of AI, that's what's driving a lot of the returns and a lot of the growth that we're seeing right now. And that's filtering throughout the entire market. And it's not just the largest tech companies.

So one of the asset classes that's doing well this year is small caps. And that's because a lot of small cap companies help plan to a lot of those themes and the infrastructure buildouts. I think the things that are less certain, if we think about other aspects of that conversation, are there was a term earlier this year, SaaSpocalypse.

And that was a question of whether SaaS or software as a service companies would be able to survive in a world of AI. And that was a problem for a few weeks earlier this year and caused a lot of volatility in the market. But, for the most part, I haven't really heard that term being mentioned in the news very much over the last few months. And I think a lot of that has settled down.

So I think the themes have gone from, well, there's just a few "AI companies" out there, and maybe they'll IPO in the near future, maybe they won't, to, how can AI benefit corporations across the board, and, therefore, support the entire portfolio. And the way to think about that, the best parallel, I think, is if you go back to the dot com boom in the 1990s, that information technology revolution.

Yes, there were a few key winners. And, of course, there was the dot-com boom and bust. But if you think about the largest technology companies today, the ones that we talked about with the Magnificent Seven, the ones that are household names, it's taken them 20 or 30 years in order to build up to where they are.

These are long-term themes. They are not just specific to individual sectors or companies. They're themes that affect the broader economy. And from a long-term investing standpoint, I think that's actually the better conversation to have, not to try to pick individual winners and losers right now, just as you might have tried in 1999 or the year 2000. But, of course, that would have been difficult then too.

How Diversified Portfolios Are Performing As Expected [24:01]

Adam: Yeah, definitely. And so, I guess putting...there's one more topic I want to discuss. But before we go there, putting it all together, it sounds like what a lot of advisors preach in terms of having a diversified portfolio is really paying off this year. You have equities being really the strong performer at a lot of performance. I think you've had both domestic and international equities performing quite well.

And then, on the bond side, while they haven't provided the return this year, as you mentioned, the yields have gone up, the income opportunity has gone up, and their ability to serve as that defensive ballast has improved as well. So that if a client, for example, is worried about some sort of AI downturn that could affect equities, that that bond portion really is well positioned at this point to serve as that ballast. Would you sort of agree with that summation, putting it all together?

James: I not only completely agree, I think you've seen that multiple times this year. So, we started the year, which I think a lot of folks have forgotten about, with geopolitical headlines around Venezuela. And so, the fact that you had overall portfolio dynamics staying balanced during that time, partly because of that fixed income allocation and portfolios, that's played a huge role there.

And so, to your point, it's one thing to just look at the headline return on fixed income and look at that in comparison with how well equities have done, but it's important to look at that overall volatility profile that's not just taking place today, but over the last nine or ten months. That's ultimately what matters. Because we all know that a lot of these dynamics could switch around tomorrow or over the next couple of months.

And what you want is that portfolio to still be fully relevant and be aligned with those financial goals when that happens. And so, yes, major bond market indices have been flat to slightly negative so far this year, but they've also played their part when it comes to the overall profile of that portfolio.

Addressing Client Concerns About The Impact Of The Midterm Elections [25:55]

Adam: Very good. The last question I wanted to bring up, which I think many advisors will feel if they have a meeting with a client in the next couple of months, are the upcoming midterm elections. Of course, advisors who have been around for a while have gone through many cycles of midterms and presidential elections, but some clients might have short memories about how they went in the past. So, what sort of data points can advisors use to put the elections into context, and what they might mean for markets?

James: Well, elections can be tricky to talk about. I know I'm probably preaching to the choir, very much so with your audience here. Like you said, they've gone through multiple, if not dozens of election cycles working with their clients. And so, the challenge we're talking about politics is, of course, that everyone has strong opinions. And really, what we ultimately need to do when we talk about investing and building financial plans is to do what we can to set those politics aside.

And I think that is a challenging thing for a lot of investors because the natural question is, well, how could it not be important what happens with politics when it comes to portfolios, the stock market, and financial investments? And the answer is that not everything that matters from a policy perspective, from a tax perspective, from a national debt perspective, ultimately filters through and affects markets and portfolios. And that concept is proven time and time again across history. But I think it can be really difficult for especially the average investor to accept.

And so, what are some examples here? Well, what we know is that, in the long run, markets follow the path of economic growth and earnings. And so, we have many charts that we've seen across history where we see that regardless of who's in the White House, regardless of which party controls Congress, you have the economy growing well, and therefore, the stock market doing well also.

Other topics that a lot of clients may actually be worried about, and maybe that's intertwined with the midterm election, for example, is really the size of the national debt. The most recent numbers show that we're at $40 trillion on the national debt, which is an astounding number. And that's well above 100% of GDP when you look at it on net terms. And I think the number that a lot of advisors might find helpful when talking to clients is that that comes out to roughly $120,000 per man, woman, and child in this country. So just absolutely staggering numbers.

But, again, the key is does this affect portfolios and markets? And I think if you took that to the extreme and you tried to use this as some sort of signal for when you should be investing and when you should be getting out of the market, it would have told you exactly the wrong thing. Because when is the national deficit the highest? It's the highest right around economic emergencies like in 2020, like in 2008. And when is it the lowest? It's when the market has already bounced back.

And so, if you were trying to time the market based on this or reacting to what's happening in Washington with your portfolio, you actually would have made exactly the wrong moves. So, focusing too much on politics can be counterproductive. And so, it's critically important that we try to educate clients by helping them understand that, yes, we all have opinions and views on politics, but let's be careful when we let that filter into our portfolios here.

One Key Takeaway For Advisors [29:17]

Adam: I think that's a really good perspective. So, now, James, given that we've covered a lot of ground today, what would be your one key takeaway for advisors on talking about the current market environment with clients?

James: Well, Adam, we've gone into some detail on lots of different topics here from inflation, and rates, to oil, to what we just discussed with politics. That said, though, I think, ultimately, the purpose here is really to not get caught up in these details. It's to not get caught up in the markets and the economy, and certainly not individual data points. It's really to help clients focus on their long-term goals.

And so, while I don't think you should ignore their concerns. In fact, we should absolutely address the specific concerns that clients have. It's more important to let them know that, we, in this industry, are a source of perspective, and insights, and that when clients do have questions about this, that they really should turn to us. They should not be turning on the TV or reading blog posts about these topics.

And if we can do that properly, then, hopefully, that helps to provide that perspective that then allows clients to really focus more on their financial plans and their long-term goals instead. So, for us, regular touchpoints to let them know, hey, markets may be uncertain right now, but we've got your back on this. And for us to be the trusted sources on that, that, to us, is really the objective here.

Adam: All right. Well, thank you so much for joining us today here on the "Financial Advisor Technician" podcast, James.

James: Great. Thanks, Adam, for having me.