Where Do Public & Private Markets Converge? (With Steven Meier)

KATHY JONES: I'm Kathy Jones.

LIZ ANN SONDERS: And I'm Liz Ann Sonders.

KATHY: And this is On Investing, an original podcast from Charles Schwab. Each week we analyze what's happening in the markets and discuss how it might affect your investments.

LIZ ANN: Well, hi, Kathy, as usual, lots to discuss this week. We did get, yesterday, as you and I are recording this, the preliminary benchmark revision that the Bureau of Labor Statistics announces—it's a revision for the year ending March of this year, March of 2025. So it covers a period from April '24 to March of '25. And it was an historically large downward revision, 911,000 jobs taken out of the tally. We'll get the final reading on that in February of next year. But what is your take, given what we know now?

KATHY: Well, as you said, it's a large revision in number, but it's not out of the ordinary. So we do see large revisions, particularly when conditions are changing. If you're into recession, coming out of recession, you don't really know that. You tend to these turning points, you tend to get the larger revisions. It's very hard to capture kind of economic changes in real time with the survey data.

And this has been particularly difficult because of, as we've discussed many times, the lack of information from surveys. The benchmark revisions try to match up the job figures with the census data. And we've had a lot of shifting in the census data as well, population changes. But I'd like to emphasize that this represents a 0.6% change of the overall employment numbers. So, although it's a big number in nominal terms, in percentage terms, it's not that big a revision when you look at the overall numbers. But look, it paints a picture of a softer job market than had been previously believed. And combine that with the Producer Price Index we got today that was on the soft side. I think from a market perspective, it raises the likelihood of a Fed rate cut at the September 16-17 meeting. I think the market is now building in some expectation of a 50-basis point cut. I still think that that's probably not going to happen, but we certainly could see a couple of rate cuts over the course of the next couple of months as the Fed meets if the numbers continue to be on the soft side. So what about you, Liz Ann? What was your take?

LIZ ANN: Yeah, I'm glad you pointed out the context of the big downward revision as it relates to the total number of people employed in the United States. If you were to chart, as many people have, including us, just the size of the benchmark revision and compare it to historical benchmark revisions, it's an eye-popping chart. But if you were to do a chart of overall employment in the United States pre- and post-revision, they look like the same line, basically. So I think context is always important. What's come into play over that reference period, the one year through March of 2025, is immigration may have a lot to do with the size of that revision because the way payrolls are reported at the outset is from the Establishment Survey that the Bureau of Labor Statistics does. And it's a survey of companies about their payrolls. 

What is done to get the annual benchmark revisions, it comes from a quarterly census survey which looks at actual tax records, unemployment insurance tax records. So what can happen when you've had decently high immigration, although trending down in the past couple of years, is that companies may have reported folks on payrolls, but when it comes to doing the tax piece of it and unemployment insurance rolls, undocumented workers don't find themselves on those rolls. So that could also explain why… the differential between the initial payroll reports and these subsequent benchmark revisions were so huge. I agree with you. I think the likelihood of 50 basis points is very low. 

Notwithstanding what is, as we're taping this, was a relatively positive Producer Price Index report coming in below expectations and the components within the PPI that feed over to the Personal Consumption Expenditures price index, which is the Fed's preferred measure, don't suggest any meaningful upside to that Fed preferred measure. So I think that that keeps 25 sort of firmly in… in our and probably most Fed-watchers sights. What else has been on your radar this week, Kathy?

KATHY: Well, I just want to point out on that topic that both the inflation report and the jobs report are produced by the same bureau, the Bureau of Labor Statistics. So if you're going to say you don't believe one number, then you have to not believe the other number as well. 

LIZ ANN: Good point.

KATHY: Or you believe they're incompetent in one area, but competent in another. Just saying, you know, don't shoot the messenger necessarily. 

LIZ ANN: Very good point.

KATHY: Yeah. But you know, I think the real question here is… there are a couple of things that are of top-of-mind for me. One is how much leeway does the Fed have to cut rates in an environment where, although the inflation reading was better than expected, it's still somewhat elevated, particularly for goods prices? So do they have to be cautious about taking a little bit more time to see what happens with those? 

And then secondly, when they're considering other things like financial conditions, and you know where we are in terms of credit availability and all those conditions are still pretty loose. So is there an urgency for them to move very fast? I don't think so unless we get a series of labor market reports that are really, really soft.

But other than that, I'm watching the global markets very carefully because we're seeing a lot of volatility in global bond yields, led by Japan. We're seeing rising yields in Europe as well. A lot of fiscal concerns, a lot of budget concerns and political concerns about "Will countries get their act together to be able to manage their public finances?"

And I think that that is adding to the potential volatility in the US market as well. So, I think keeping an eye on it hasn't had a huge effect on the US Treasury market yet, but it's certainly out there in the atmosphere as something that we need to keep an eye on because loss of confidence or dwindling confidence in the ability of governments to handle public finances means higher yields, all else being equal. So, it's something I've been keeping an eye on.

On that topic, we have a special guest this week. 

LIZ ANN: This will be an easy one, although I'll still have to read his detailed bio. Steve Meier is our guest. I have known him for a really long time. One might assume it's from the business, but Steve Meier is my brother-in-law. So, I've known him for as long as I've known my husband.

But to put a more formal stamp on things, Steve is the Chief Investment Officer and Deputy Comptroller for Asset Management for the five New York City retirement systems. And that is the fourth largest public pension system in the United States. Steve has over 40 years of experience in both the public and private sectors, previously serving as Assistant Treasurer and Interim Chief Investment Officer for the Connecticut Office of the State Treasurer, Shawn T. Wooden.

He oversaw the investments of Connecticut's $40 billion public pension system. Before that, Steve spent 17 years at State Street and State Street Global Advisors, where he served as executive vice president and chief investment officer for global fixed income, currency and cash management, overseeing more than $900 billion in assets. He was also a member of State Street Global Advisors Investment Committee for more than a decade with responsibility for more than $2.3 trillion in global investments. 

Prior to Steve's time at State Street, he worked at Credit Suisse First Boston as director and global head of fixed income and money market electronic trading and senior trader in their global financing group. His experience also includes roles at Oppenheimer Capital, Merrill Lynch Capital Markets, and Irving Trust Company. He's also, by the way, just a really great guy. 

LIZ ANN: So Steve Meier, thank you so much for coming on our podcast. We really appreciate it.

STEVEN MEIER: No, thank you for having me. It's a thrill.

LIZ ANN: So it's a real thrill for me and this is the full disclosure part of our episode here because I have known Steve for about 35 years, and not through the business world per se although I know his reputation, Steve Meier is my brother-in-law. So he is my he is my husband's brother, there's three of them and my husband is the youngest and Steve is the middle and then they have an older brother Bill, so full disclosure, but we don't have to share any family secrets. 

STEVEN: There are many.

LIZ ANN: There are many, many of them probably boring, but you have such a fascinating job, Steven. You've been in the business a really long time and I've had conversations with you over the years where you said the role that you have now is kind of a dream job for you. So before we launch into the conversation, we bring Kathy in, tell us a little bit about what it is you do, your constituents, and maybe what a day in the life of Steve Meier looks like.

STEVEN: Sure, sure, I'd be happy to, Liz Ann. So I have the privilege of serving as the Deputy Comptroller and Chief Investment Officer for the New York City retirement systems. It's actually five separate and unique retirement systems for fire and police and teachers and other city workers. I have the privilege of managing over $300 billion in assets across all public and private assets. I serve almost about 800,000 participants and beneficiaries of the plans.

And it has been a whirlwind. I've been in this position…. I'm in my fourth year now. And I'm happy to say that the performance has been quite strong. We've exceeded our 7% assumed rate of return for the last three years, quite significantly last year, the last couple years in double digits. So it's been, you know, a tremendous experience. And I'm very, very grateful. It's the best job I've ever had. And, Liz Ann, you touched on this earlier. I've had a long career. I've worked in sales and trading investment banking and asset management for 43 years now. And I have to say the last three plus years have been certainly a highlight of my career. It's been a privilege to serve and work with the people here in New York City.

LIZ ANN: So Steve, I have a broad question then about the people you serve, firefighters and police officers. And it comes from the perspective of working at a company, Charles Schwab, that has always been about financial literacy and making sure that our clients as individual investors understand as much as they can about the art and the act of investing. So how do you think about the education side of what you do and keeping the participants informed and in a position to actually understand the inner workings of what you and your team are doing?

STEVEN: That's a great question. And it's not just our participants, Liz Ann. I actually service and support 68 different trustees across the five plans. And they are what you'd guess, they're firefighters, they're police officers that still carry guns, and they remind me of that when I meet with them. They're teachers that, on occasion, will correct our investment recommendation memos. And it's what you'd expect. The police typically don't read a lot of the content we give them, but they require them to come in, meet with them. And they said we're trained to know when people are lying to us, and we want to shake their hand and look in their eyes. 

The teachers require all their write-ups upfront two weeks beforehand, otherwise it's bumped to the next meeting. So it is just really interesting. I spend a lot of time in the educational piece. I'm at their beck and call. One of the things that we've done that has been really effective, actually two things, where we put together the Bureau of Asset Management, which is the division I head here in New York City, the Bureau of Asset Management University or BAM University. We do that every year for educational purposes. It's a two-day event. 

We've had the privilege of having a number of wonderful speakers attend and present at that. I also have something called the Thought Leadership Speaker Series. Every Friday morning, it's only available through Zoom from 10 to 11:00.

And we have people come in, for example, we had Lori Calvasina. I'm sure you know her from RBC. She's a very, very prominent equity analyst. We've got Harvey Schwartz coming up. We've got TPG's Jim Coulter. I've had, you know, former Vice President Dan Quayle. We've had four US Treasury Secretaries, Fed Governors. And it's wonderful. It's a way to just, in an informal basis, I typically interview them and ask them, you know, how do they think about the markets? How would they…. what recommendations they would have for the trustees? 

So it's been an absolutely wonderful engagement. It's probably the highlight of my week. And I think that also applies for many of the trustees. They really enjoy that interaction. And for me, it's also, I don't want the Bureau of Asset Management to come between the trustees and their external managers. So that's a really important touchpoint as well.

LIZ ANN: Yeah, let me key off of that and then bring Kathy in. One of the areas I think that requires a lot of education, but there's an increasing amount of interest is in private markets. You have written about and speak a lot about, I just listened to a recent podcast on which you were a guest, talk about the convergence between public and private markets and that although private markets, one could argue, there's a better business model, but there's a lot of nuances, especially with regard to just understanding the structure, liquidity, transparency, fees so talk a little bit about the that convergence as you call it between the public and private markets.

STEVEN: Yeah. Maybe start off, Liz Ann, answer the question this way. So I think there's a number of different trends in the marketplace that are going to impact returns over a long time-horizon, 10 years and beyond. And those trends would include decarbonization of the economy, an aging population demographic changes, and the impact on labor force dynamics, deglobalization. Some of that's tariff-related as we try to re-industrialize our base here. I'd say the sustainability of foreign sovereign debt would be another issue, including the US. And I know, Kathy, you've spoken many times, very articulately, on concerns around fiscal deficit spending, transformational technologies such as artificial intelligence. So these key themes are going to impact performance over time. And the way they impact performance is they're going to have an impact on US and global growth, productivity, inflation, government spending, and capital flows. And those things, I think, will really be the performance drivers for the next 10 years.

They apply equally to the public markets as they do the private markets. So there are those nuances that you discussed, Liz Ann. They are different animals. They've got their own nuances. They've got their own language. They've got their own industry players. I know that there's been obviously a big move towards, and I think it's a positive move towards, the democratization of the private markets, meaning giving retail investors, other than high net worth individuals, such as individual investors such as ourselves, an investment in 401(k) plan will have access to these private assets. 

The private markets are a significant part of the US economy where they see a lot of innovation, a lot of growth, and a lot of wealth creation. So I do think it's a positive that retail investors such as ourselves will have access to those investments going forward at some point in the future. But you do want to make sure that you pick the right managers. You know, the performance return a lot of times is a function of picking the right manager, for example, in private equity that is really expert at value creation and building those businesses and being very strategic. There's a lot of dispersion between those managers. You really want to pick the top quartile if you can. Top half would be also pretty significant. What we do is we aggregate our $300 billion in assets and we use our buying power to get better economics, access to the best managers, marginally better legal terms, better fees, and a healthy dose of something called co-invest to actually average down no cost, no carry and the expenses. 

So as individuals start to think about investing in private assets, you're right, it's picking the right managers, making sure you have a compelling economic arrangement in terms of fees and carry, and being a patient investor. These are not deals you move in and out of. Typically, the value-creation mechanism for private equity is, five to seven years. It can be as long as 12 to 15 years in growth equity. These aren't trading positions, and again, it's for long-term value creation over time. They also have their own nuances. We talk about total return in equities and fixed income. In the public space, they talk about internal rates of return and carry and distributions to paid-in capital. So there's some nuances there, but essentially, they're all going to be impacted by those major trends that will impact the economy more broadly in the public and private sector. 

LIZ ANN: Kathy, you want to jump in?

KATHY: Yeah, yeah, well, thanks, Steve. That's a great description of kind of how you think about the private markets. You know, I focus most on fixed income and you touched on that that sustainability in sovereign markets. So are you, as an investor with this pool of money, for those for the fixed income portion of the portfolio, are you looking outside of sovereign government debt? Are you looking at corporate debt? How do you think about that, especially because a lot of what you have to do is invest for the real long term, right? You're not trading in and out of short-term positions, I assume. So how do you think about that? 

STEVEN: Well, first, Kathy, that's a great point. Thank you for the question. So you're absolutely right to say that. We're strategic and not tactical. We can't be nimble. We're 300 billion in size. We can't move in and out really efficiently. And that's not really what we're paid to do. So we're strategic. And you're right. We work through a strategic asset allocation plan that we do every three to five years. We are significant investors in investment-grade corporate credit, as well as high yield.

As you know as well as anyone, Kathy, the credit spreads there are very tight. They're not necessarily compelling. Base rates are higher. You have still three months so far above 4%. And those floating-rate obligations still can kick off some yield. We actually don't invest in non-US bonds. And the reason is we have restrictions in terms of how much alternative assets we can invest in.

The city of New York and actually the state of New York works off a very old legislation that dates back to the 1930s. And that legislation had a list of those acceptable investments that were prudent. And what didn't fall on that list fell onto the prudent investment basket. And that includes non-US bonds, includes non-US stocks at certain limits, it terms of high yield over 10 percent, and then all manner of private assets.

We're very careful in terms of how we use that basket allocation. I also think some of this thinking might be legacy at a point when US rates were much higher, we had negative interest rates in Europe, you had obviously the issues around currency and the potential need to hedge. In our private credit book, we do actually invest in European debt, mostly in the direct-lending space, some asset-backed funding as well. But I do think that as a component of the portfolio, corporate bonds are consider a risk asset. They're not necessarily the ballast that you typically want in fixed income, but they're certainly something that can generate a significant amount of carry for us in yield. The other challenge we have, I guess, that I mentioned in the context of bond investing is the fact that we've had relatively high levels of correlation between equities and bonds and US Treasuries in particular, really since COVID, 2020.

And there we really don't get the diversification benefits of owning Treasuries. Now that may reverse at some point. I think it's more of a function of inflation and how that's impacting real rates in the underlying economy. But again, we typically have those balanced portfolios that have both private and public assets across equity exposure and fixed income exposure. And again, outside the states, we do invest in strategies that in the private sector that have more exposure to non-US economies.

KATHY: I was also wondering about the inflation component you brought up, because obviously that's going to be a huge issue for your constituency to try to have returns that exceed inflation. And for a few years, that's probably been difficult. Or over some of those years, it's been difficult to even doing this. Do you go into TIPS, Treasury Inflation Protected Securities, at all? Or how do you think about the, you know, staying ahead of inflation as part of the portfolio?

STEVEN: So we have other things in our portfolio we think are better hedges against inflation, our equity exposure, our infrastructure exposure, our private real estate exposure, for example. We were investors in TIPS, and then the last strategic asset allocation, we actually removed them. And I'll tell you why. What we found out is in a period of time, '22, '23, when inflation really spiked, your TIPS really didn't outperform. They still had a significant amount of duration and underperformed. They outperformed nominals, but they underperformed our expectations in terms of returns. 

And the reason for that is 10-year TIPS would typically trade off of 10-year inflation expectations versus something that was a shorter-term increase in inflation like we saw after COVID. So the performance there was disappointing. We thought we'd get better exposure, better inflation protections in other asset classes.

KATHY: Yeah, TIPS you have to kind of match them up to your holding time period. 

STEVEN: Yeah, yes.

KATHY: And 2022 was a tough year for TIPS holders. They thought they were going to great, and they didn't. Yeah. Totally agree with that. So one more question, then I'll toss it back to Liz Ann. I am curious as to how you balance the liquidity issue. So it sounds like you have a fair amount of private investment, which has liquidity challenges. So how do you balance that with your need to have these payouts regularly? I recall, well, during the financial crisis when interest rates were down to zero, basically, and even bond yields were very low, I was at a meeting with one of the managers of CalPERS, the California pension fund…

STEVEN: Yeah, they're excellent.

KATHY: Yeah, and he was… boy, they were struggling at the time because their payouts were above the rate of return that they were getting on their fixed income portfolio. So obviously that's turned around now, but you still have to have that liquidity component. So how do you go about addressing that?

STEVEN: So for us, liquidity has been less of a consideration than it is for say CalPERS or Texas Teachers or some of the other funds out there. And it's because of the basket clause I mentioned earlier. We're capped at about 35% maximum in alternative investments. Right now we're slightly under that, about 28%. We'll probably move to increase that over time through pacing plan allocations. And we're proactively doing that. For us, because we're restricted in terms of the level and the amount of private assets we own, it's less of a consideration. So there are some public pension plans out there and certainly a lot of endowments out there that have 50, 50+ percent allocated to alternatives. They're not liquid. They're not nearly as liquid as the public market is. For us, I mean, we need to make sure we have enough liquidity in order to meet our benefit payments, first and foremost. And we have a legal obligation to meet our capital calls as they come for the private assets. But those are very good questions. 

The other thing that we did in our private equity book this year is we did have a secondary sale. We've actually never undertaken that in the past. We sold almost $5 billion worth of net asset values through a competitive bidding process. We sold to a very small number of bidders. I'd say the information value there and the good news is we had 88 firms that actually bid on either all of the holdings or some component of the holdings. And what that tells you is that there is liquidity out there, but it's a lengthy process to go through in terms of getting board approval, hire an external broker. The legal and operational challenges associated that were really significant. You need to get consent in order to transfer ownership of any of your private assets or holdings. We actually sold 125 different line items with 75 different investment general partners or asset managers. So it was complex. I don't know that we'd want to do it again tomorrow, but it does tell us that that's an option as you need to raise liquidity even in private assets.

KATHY: Great. That's interesting. Liz Ann, I'll let you…

LIZ ANN: So Steve, I have one more, I guess, might be seen as a two-part question with regard to the private markets, particularly private equity. But then I then I have a question on the public markets, which is more my bailiwick. So, and correct me if my data is wrong, but the latest that I have seen suggests that among private equities, there's about 12,000 portfolio companies. But the latest tracking is only about 1,500 exits on an annual basis. And then the other sort of reason for some caution or some concern is that distributions, which I think in the past have been as much as 30% of net asset value are down to around 10% of net asset value. So there's that question in terms of the dynamics within private equity, but then also more recent criticism, especially given some weakness we're seeing in the labor market, including the revisions that we got today as we're recording this that private equity in its current structure hasn't really been tested by what we might define as a true recession, leaving the COVID recession, which was so short-lived aside. So tackle in whatever order.

STEVEN: Well, I think we are seeing a little bit of a recession, let's say challenges in private equity. We certainly saw a bear market and mergers and acquisition activity in IPOs in 2022, 2023. It spilled over to 2024. And I hate to tell you, it's still spilled over to 2025. M&A has picked up and IPOs have picked up, but not to the level to your point earlier, Liz Ann, 2021 was a banner year. There were incredible exits and flows out of those private equity general partners into the hands of their investors. So you're right, it's been a challenging time. I think the performance of private equity in terms of its return stream certainly reflects that. But here's the thing: it's been really a challenging environment for many investors that maybe have been overweight private equity. We're underweight and we're increasing our allocation of private equity. So for us, we've been in the catbird seat in terms of putting more money to work in an asset class that is a little bit out of favor.

And, you know, with really great general partners or managers that have had difficult capital raises. So we've been able, again, to get better access to better managers to negotiate marginally better legal terms. And again, really much more compelling fee structure and a healthy dose of co-investment, almost with a two to one ratio where we're getting so much more co-investment, no fee, no carry. So I actually think over the last three years, it's my tenure with my, you know, the aid and working with really wonderful people here at the Bureau of Asset Management, we've really positioned the portfolio for outperformance. But that outperformance in terms of co-investment and how we're positioned with what I think will be very good vintage-year investments, you won't see for another 5, 7, 10 years. So we do think we'll power the performance down the road, but those are really great questions and really great insights. It's been a tough time for private equity.

LIZ ANN: All right, so let's move into the public markets, which is more my domain. And maybe just talk about, you mentioned you're a little below what the limit is on private investments within the fund. So maybe a broader question of what the current strategic asset allocation is across asset classes, but also how often does that change? And then I want to ask you about where you see opportunities within the public markets.

STEVEN: So the strategic asset allocation typically should be done over an economic or a market cycle. It should be done every three to five years. Oftentimes they're done more frequently. So for example, you've had three years where you've had really incredible performance out of US equities. And I know a number of public pension plans, including ourselves, are looking at that and saying "Maybe it's time to reevaluate. What do we think the next 10 years are going to bring in terms of return streams or annual returns for public equities?"

What does the volatility of those returns look like and what's the correlation with the other assets? And that's basically the building blocks for constructing a portfolio. You know, I still think there's… well, a couple things. I think that we're perhaps a little overweight in US equities relative to the rest of the world. You've seen some relative valuation disparities open up. I mean, US markets have outperformed. US preeminence has really driven that outperformance over last 12 years following the global financial crisis.

And I think for some investors, they tend to be slightly overweight, large-cap, large-cap growth, which has worked really well and continues to work well. But at some point, I think there's probably better ponds to fish in. If you look at non-US equities, last year they outperformed US equities and with a strong tailwind associated with the declining dollar relative to those local currencies.

So, I do think that's something we will continue to look at and explore is potentially higher holdings outside the states. But again, given the nuances of how we calculate our basket in that 35%, we probably want to focus it more on private equity. For example, our expectation is you'll see more than double the returns in private equity over a 10-year horizon than you will, in public equities, given the tremendous outperformance that we've seen over the last couple years in the public side here. So, and again, the fact that it's been a little bit challenging on the private equity side. 

You know, one of the other things you touched on earlier, though, that I think is worth mentioning is, you're right, it's been a difficult capital raise environment. There are a lot of companies out there in the private equity space, not the underlying portfolio companies, but managers that are struggling. There's a statistic out there that about 40% of public equity managers have not had a successful capital raise in five years. And that doesn't bode well for those companies. So I think you'll see probably a significant amount of consolidation among private equity managers, some going out of business. And again, that's why when I said up front, you really need to look at picking the best managers that can really focus on value creation, that have a track record of doing so, and that can consistently produce returns in the top quartile.

LIZ ANN: You mentioned some concerns about maybe sort of frothiness and valuation excess within the large-cap area, mega cap, tech, AI-related. So where do you think maybe their opportunities lie? Is it down the cap spectrum? Is it into other industries or sectors that may not be as AI obvious or focused as what has been kind of the dominant performance driver in the last few years?

STEVEN: Well, it's been the dominant performance in the public market for sure. I actually believe it's going to be the dominant performance driver in private equity as well, and venture capital. We're starting to look at some venture capital vehicles. And we met with a firm yesterday that talked about the tremendous value creation that is occurring so quickly in the AI space or AI adjacency. So I do think we still want to be invested in equity. I still think that there are some….if you look at the economy, you're right, employment's moved up, inflation's still little bit of a problem, the Fed's probably going to cut next week anyway. 

We've got the tariffs out there, there's still a question mark in terms of the ultimate impact to the economy. You have the offset of artificial intelligence, the potential for increased growth and reduction in inflation and increase in productivity. So there's a lot of unknowns out there that really kind of have you scratching your head, but, again, as a long-term investor taking a 10-year horizon, we still like equity exposure, we still like artificial intelligence exposure, and the adjacencies. 

So a couple things on that front. We have significant investments in, say, infrastructure for data centers, for clean energy that can provide and power those data centers in support of artificial intelligence. If you looked at our private equity holdings, about 25% of those underlying strategies and those underlying portfolio companies are tech related or software related, in particular. So we do think a lot of those nascent, those up-and-coming companies that are AI-related will actually help, again, the performance over time. And we want to certainly have exposure to those institutions.

LIZ ANN: Kathy, any other questions? I have one broader kind of fun angle to a question I want to ask Steve next, but wanted to let you jump in.

KATHY: I appreciate that. I could probably talk to Steve now for the next three hours about asset allocation decisions because I find that to be a really…. I know it's something we talk a lot about Liz Ann and in our group at Schwab is how do you really get a methodology around asset allocation? 

So I've worked with couple of different firms on Wall Street everyone has approached it a little bit differently. So broadly speaking, and you said 3 to 5 years for strategic and then more frequently tweaking sort of your positions, but do you sit and say, "What are the mega trends for the next 10 years and therefore this is how we want to be positioned?" And then how do you revisit that? Say you're wrong about that or the world changes or AI doesn't turn out to be the boom that everybody thinks it's going to be. I mean, I'm really just interested in the process you take when you think about asset allocation broadly.

STEVEN: You hit the nail on the head in terms of our approach. We try to get a sense for what do we think the mega trends are, and not themes, but mega trends are the impact, again, the broader economy over the course of the 10 years. And then how do we position to take advantage of that or protect ourselves from that. The one thing that we really haven't talked about, Kathy, and I'm dying to talk to you about this, is just the fiscal discipline and part of the US government challenges in the Treasury market, independence of the Fed. 

I mean there are a lot of things out there that honestly, the Fed has I think telegraphed a willingness to cut rates probably 25 basis points next Wednesday. We get a new summary of economic projections or dot plots which will inform expectations for the rest of the year. I'm concerned about where rates are and where they're going, and I do think you could see a situation where the Fed cuts aggressively for whatever reason on the short end of the curve and you can have a significant backup on the long end. The term premium is widening out already. Premium out, the curve is widening out.

I think that's good for investors, though for this reason. I think if you keep some level of reasonable base rates, again you can continue to generate carry and return off that portfolio notwithstanding some level of volatility.

KATHY: Yeah, I 100% agree. know, steeper yield curve ahead. It's what we've had most of this year. And it looks like we'll continue to have it unless we magically figure out a way for Congress to address the fiscal situation. And that's global, too.

STEVEN: Yes, yes it is.

KATHY: I mean, think it's, you know, Japan, Europe, it's happening everywhere. So it's not just us, aging population driving a lot of that. So yeah, I think steeper curve in that. You're right, it's great if you're kind of concentrated at the short end and you're trying to use carry to get returns, but it's got to be a challenge for the riskier parts of the market as well.

STEVEN: And again, credit spreads where they are right now at 80 basis points for investment grade, 280 basis for high yield. It's not really compelling. It's not super attractive. It's not on a historical basis. And not given the level of uncertainty that we see developing in the economy. I tend to be a little bit more optimistic than pessimistic, believe it or not. And that's odd for someone that has a foundation in fixed income. I know you equity folks, they're always optimistic about the outcomes.

KATHY: I was going to say that doesn't describe me. I'm always the pessimist in the room. So Liz Ann's always the optimist. Yeah.

STEVEN: I'm converted, I'm converted.

LIZ ANN: Well, that that's so funny that you just mentioned that because that was the fun angle I was going to have on this, Steve. In another recent podcast episode, you talked about being a kind of a natural skeptic, maybe by virtue of having been on the fixed-income side of things for as long as you have. 

Kathy and I have often joked about that, about maybe what you could liken bond investors to and equity investors to. And Kathy, I remember before you and I got on stage once, you talked about the stock market being more like an untrained puppy. So, is that a good way to think about the differences? And maybe, who do you think right now, or what market has it more right? The fixed income market or the equity market?

STEVEN: I think that the fiscal outlook is going to matter more than it does now. I think it'll be less of a focus on macroeconomic and more of a focus on where are we from a fiscal standpoint, what does inflation look like? Independence of the Fed has to be part of that discussion as well.

So if I had to get… I mean, valuations right now in equities are very high and they have been for a little bit of time now and, you know, I don't necessarily see a crash or a significant bear market, but I could see a correction of 5 to 7, 7 to 10%. And, you know, I do think over time that you're going to see the potential for base rates to move higher. Again, is that concern around fiscal discipline reenters the discussion?

Inflation maybe is a little stickier than people expect. And then real questions about the independence of the Federal Reserve, given some of the rhetoric out of the current executive branch.

LIZ ANN: So Steve, this has been great. I don't know if you're aware of this, but this is extremely rare for one of these interviews to have both Kathy and I peppering the guests with questions. 

STEVEN: I'm honored.

LIZ ANN: We usually divide and conquer a bit depending on whether somebody is more focused on the fixed income side or the equity side of things, whether it's an internal guess that we have, whether they live in Kathy's team more or my team more, but just a testament to your breadth of knowledge and the unique position you're in that we both raised our hand to sit in the interviewer's spot with this. So thank you for indulging questions from both the very calm skeptic and the person representing the frenzied equity market. 

STEVEN: Thank you to you guys as well. It's been a real privilege. 

KATHY: Okay. So, Liz Ann, that was great. Thank you for letting me horn in on that interview. So, looking ahead to next week, obviously we'll have the big Fed meeting where they are expected to cut rates. What else do you think investors should be watching?

LIZ ANN: So in terms of the economic calendar, as we mentioned earlier in the show, we do have in hand, as you and I are recording this, the Producer Price Index, but in advance of us recording this, we have the Consumer Price Index. So in terms of very near-term things, that's on the radar, although by the time this episode drops, everybody will have that information. You know, aside from the FOMC meeting next week, we also get retail sales. And I think that continues to be important as a proxy for the consumption side of the economy, especially in light of weaker labor market data, which has been such an important support for the overall economy, and specifically consumption. 

I think the claims data bears watching because there's been a theme that continues to be dominant in terms of how we think of the labor market, a theme of low hiring, low firing that helps to explain the spread between the unemployment rate, which although up from its lows recently is still relatively low in an absolute sense, but long-term unemployment, those that have been unemployed for more than 27 weeks, that has been trending higher. So that's another example of this low hiring, low firing mode. So therefore, the claims data, I think, is important. 

You and I track the differential between initial unemployment claims and then continuing unemployment claims, people that continue to stay on unemployment insurance. And that also has represented a bit of a proxy for that low hiring, low firing. So those are a couple of things on my radar. Oh, I should also say just continuing to watch some of the rotations happening within the equity market. On a quarter to day basis, small caps via the Russell 2000 have almost doubled the performance of the S&P 500.

I think a lot of that is based on the assumption of easier Fed policy, which all else equal, is seen to is accrue more to the benefit of smaller companies. So whether we can maintain that strength, relative strength in small caps is something on my radar. How about you?

KATHY: Yeah, in terms of the data, the one thing that I'll probably be focused on more than most people is the Treasury International Capital report. And that's that just shows you the inflows and outflows of capital from abroad. And it's been very interesting lately that official purchases of say, Treasury bonds, meaning other central banks and other sovereign-type institutions have been reducing their purchases of US Treasuries, but foreign households have been increasing. So, you'll see if that dynamic continues or if the prospect of lower interest rates in the US has kind of discouraged that. 

We've also seen a lot of foreign households buying US equities as well. That's been a support to the market. So, it'll be interesting to sort of follow those numbers. They tend to lag a little bit, so they're not great for timeliness, but very interesting to see where the flows are going, particularly in a world where we have trade wars going on and we have all these other conflicts brewing. See where people are actually putting their money is pretty interesting to me.

So, that's it for us this week. Thanks for listening. You can always keep up with us in real time on social media. I'm @KathyJones. That's Kathy with a K on X and LinkedIn.

LIZ ANN: And I'm @LizAnnSonders on X and LinkedIn. My usual announcement to make sure you are following the real me as I continue to have a lot of imposters. And as a reminder, you can read all of our written reports. They often include just a treasure trove of charts and graphs. You can find them at Schwab.com slash learn. And if you've enjoyed the show, we'd be so grateful if you would leave us a review on Apple Podcasts, maybe a rating on Spotify or feedback wherever you listen or tell a friend about the show. And we will be back with a new episode next week.

LIZ ANN: For important disclosures, see the show notes or visit schwab.com/OnInvesting, where you can also find the transcript.