The 2026 Market Outlook: Earnings, the Fed, the Magnificent Seven, and Long-Term Investing with Liz Ann Sonders (EP.239)

0:21Welcome back to The Long-Term Investor. Today's episode is a very special one for me. My guest is Lizanne Saunders, the Chief Investment Strategist at Charles Schwab, and she is one of the most widely followed voices in markets and the economy, and someone I've been personally following my entire career. And if you haven't seen any of Lizanne's work before, she's been at Schwab for about 26 years, and I really appreciate the way that she is speaking to the individual investor to help make sense of what's happening in markets without getting pulled into the short-term noise or just these headline-driven decisions.

0:58And so in this conversation, we go well beyond the usual what's-your-prediction-for-next-year kind of interview. Lizanne explains what it really means to be an investment strategist, why she doesn't believe in year-end price targets, and what she thinks forecasts should be used for instead. We also break down some of the biggest lessons from 2025, and what kind of environment to expect in 2026, from earnings and inflation to market breadth. From there, we dig into the Federal Reserve, the dollars reserve, currency status, and what investors should and shouldn't do when it comes to thinking about the U.S.

1:32debt. But before we get into it, quick favor, if you are enjoying the show and you want more long-term context like this between episodes, you can sign up for my newsletter using the link in the episode description. It comes out every other Wednesday, and I regularly link to research and thinkers like Liz Ann so that you can stay informed without getting overwhelmed. All right, let's dive into it. Here's my conversation with Liz Ann Saunders.

2:01Welcome to The Long-Term Investor. I am thrilled today to be joined by Liz Ann Saunders, Chief Investment Strategist at Charles Schwab. Liz Ann, thank you so much for joining me here today. Oh, it's a pleasure, Peter. Thanks so much for having me. If you had told me when I started this podcast that someone like you would eventually be a guest, I'm not sure I would have believed you, but here we are. And if you're watching us on YouTube or watching us on Cheddar News, Lizanne, we're going to have a big intro on the podcast for her. But as chief investment strategist, I'm curious if we can start there.

2:32Just tell us to you, what does that even mean? What is your role there? Peter, it's a funny question because it makes me think of this as many years ago now. I got asked to be part of career day at my daughter's middle school. Now, she'll be 26 in a week, so that's how long ago this was. But it was a cool event where they had parents come in, and as a parent, you stayed in one classroom, and the kids rotated. They picked three or four careers that they wanted to hear about. But I remember the prep call with the principal and their suggestion that we figure out how to explain what we do if it's a complicated thing, something other than, say, a police officer, in a manner that middle schoolers could understand.

3:17So I thought, boy, how do I do that? I remember saying, well, I read, write and talk for a living. That's the basics of the day to day. Up a level of sophistication in terms of the answer. I sometimes jokingly say I'm the chief pontificator. But the best way to describe it is I'm an interpreter of what's going on both in the economy and the market and try to distill that interpretation in a way that is beneficial to our individual investor audience base, which I mentioned that specifically because we are not a traditional Wall Street firm in having institutional clients, hedge funds and money managers and mutual funds.

3:58the audience and the need for information, how they use that information is very different than, say, what the audience is for a strategist at a Goldman Sachs or a Morgan Stanley. So it's all geared toward the individual investor in helping provide guidance, helping them understand the interplay between what goes on in the market, what goes on in the economy, and providing that perspective without trying to do short-term market timing. Well, that all resonates with me. having read your work for nearly two decades now, I first latched on to your words during the financial crisis, and you were one of the people who it seemed like was focusing not just on the craziness, but just trying to find the bright side of things, not necessarily in a head in the sand, everything's going to be great, but like you just mentioned, with some perspective and your 2026 outlook is out.

4:49We will certainly talk about that. But a lot of people in your role, I think, get associated with forecasts. And there really isn't anything in your outlook that has forecasts. So I guess from your perspective, when you put an outlook out, is that a fair assessment? You're not making forecasts. What role do you hope that that outlook provides individual investors or even the advisors who are reading it? So maybe I'll answer it in the context of why we don't do year-end price targets, which is probably the most common exercise done by strategists, certainly traditional Wall Street strategists. strategists.

5:22And there's lots of facets to why we don't do that. I will never forget the very first conversation I had about taking on this role, which prior to me, 26 years ago, the role didn't exist at Schwab. And it was a conversation I had directly with Chuck Schwab himself. He was talking to me about the desire to create the role and would it be something I was interested in, which, of course, I said yes. And 26 years later, I'm still here. And for all intents and purposes, is only my second job. I manage money for the first 13, 14 years in the business. And he specifically mentioned a desire not to fall into that trap of year-end price targets.

6:03And I think it's because it pretends precision where there isn't precision. The industry knows this. I'm writing an evergreen piece as we speak. I'm not sure when it will publish on exactly this subject, the perils of forecasting, why we don't do year-end price targets. So I'm trying to remember some of the things that I had jotted down. Markets don't move toward a destination. They traverse a path of constant uncertainty. And that's why I always chuckle at that old line of the market hates uncertainty. It's always uncertain. I've never woken up to the front page of the Wall Street Journal. It says, we know everything.

6:42Everything is certain. So I think a single end-of-year number, moment in time, 4 p.m. on whatever the last day of the year is, the volatility that happens along the way, the interim drawdowns that happen along the way, the rotations and the churn under the surface, different regimes that pop up. And I think it's perspective along the way in helping guide investors as things are happening makes so much more sense than trying to forecast what the market is going to do, especially some moment in time tied to the calendar. Frankly, and I use this as an example, I started in the business in 1986, so I was around in 1987.

7:20If a strategist had said at the beginning of 1987, they had put a price target that was like a percent change from what the starting point was, but didn't provide perspective along the way, at the end of the year, they could have said, I nailed it because the market was actually flattish in 87. Needless to say, what happened along the way was as dramatic as it comes. I just think it's a false precision. It's more about a way, I think, for the institutional world to sort of pit strategists against one another, who was right, who was wrong. I just don't think it's great advice for investors. Trying to time the market is an impossible thing to do, and therefore we don't try.

8:02I think the misperception is that that is the key to success, the get in, get out, try to pick tops and bottoms. I don't know any successful investor that became successful taking that kind of approach. And that's why we don't do it. Yeah, I'm with you. I mean, I think the investor's job is not to beat the market. Every dollar you earn can't be saved and every dollar you save can't be invested. But for those dollars you're investing, I continually say on this show that you're just trying to outpace inflation without taking undue risk. Exactly. Hearing about your background, it's really difficult for me to resist pulling on the thread because I know you worked with Marty Zweig and I I know about the call that was made ahead of the crash in 1987, but maybe if we get enough time at the end, I will circle back there.

8:45And even if we don't, by the way, you can find it on YouTube. It's fascinating. Look up October 16th, 1987, Marty Zweig, Wall Street Week. Watch it. It is extraordinary because he was a rare person that did have pretty decent success market timing. It was surreal. So for all of you listening, or if you're watching on YouTube or Cheddar News, I will also link to that at the long-term investor.com. Lizanne mentions only having two jobs effectively, but the first one was really quite phenomenal. If we had more than an hour, we might go down that path. But I promised the listeners we would talk a little bit about outlooks.

9:23And before we get there, I'm just curious because we're not forecasting the future here. Tell me a little bit about what your process looks like as you're developing a 2026 or any given year's outlook. A lot of it is the melding of what's going on in the economy and what's going on in the market and trying to assess whether, say, the economic cycle has some reference to history, might be considered a normal economic cycle. And if so, where are we likely to sit in that cycle? Certainly in the recent five, six years or so, understanding the unique aspects of this cycle and kind of the post-COVID environment, trying to explain maybe the differences in how this cycle is unfolding and that we shouldn't think of it in linear fashion, that it's not early cycle, mid cycle, late cycle, boom, recession comes.

10:14There's so many nuances to understanding economic cycles and then the application into what the market environment is. My framework and just the way my brain works, there's other firms that do this. I know Keith McCullough very well. I do his summits quite often. GavCal is a firm we get really great research from and we do some research sharing with them. that quadrant framework where you think of the big drivers that are economic drivers, but that have direct influence on the market. So the direction of inflation, up or down, high or low, the implications that that has for monetary policy. Are we in an easier cycle, a tighter cycle?

10:59Are we transitioning between one and another? Marty Zweig coined the phrase, don't fight the Fed. So I grew up in this business, learning that part of it, understanding investor sentiment. He used to call that the investor liquidity component. Understanding the relationship between investor sentiment and consumer sentiment and the interaction between those two. Looking at the trajectory of earnings and understanding the valuation backdrop. Keeping in mind that, as we always like to remind investors, valuation is a terrible market timing tool. We already discussed the fact that I don't think there really is some foolproof tool for market timing.

11:39It's an impossible or nearly impossible thing to do, notwithstanding October 16th, 1987 with Marty Zweig, because valuation is almost an indicator of sentiment. Valuations can get stretched and get more stretched and even more ridiculously stretched, and it doesn't represent some timing tool. But understanding the interplay and understanding, okay, if we're in an environment where valuations are seemingly rich, what does the earnings backdrop look like? Maybe one of the most important things I do, and I try to impart this to investors when I talk about both my process, but where we might be in a cycle.

12:13I'm a big believer, and I've been saying this for my 40 years doing this, better or worse often matters more than good or bad, especially as it relates to the connectivity between what's going on in the economy and what's going on in the market. It's human nature for us to think, Was it the data, a jobs report, a retail sales report, a GDP report, whatever it is, or earnings? Was it good or was it bad? Was it strong or was it weak? But better or worse is the determinant, more often than not, of what the market does. And that's why it really confounds investors at times, especially if you're flying high in the economy.

12:52And more often than not, if you're going into a bear market, that comes first before you start to see the obvious signs in the economy. And that has to do with the market's uncanny ability to sniff out inflection points. But you think about inflection points. When the data stops getting better and starts getting worse, at that snapshot in time, you're at the apex, you're at the peak. In absolute terms, in level terms, the data still looks fantastic. Conversely, when you're at the bottom and the economic data stops getting worse and just starts to get better, the market tends to sniff out that inflection point.

13:28But at a snapshot in time, you're at the bottom. Without knowing that you're about to improve, the data looks absolutely horrific. So if you just look at when bear markets have started, when bear markets have ended, and then look at that moment, especially pre-revision, what the data looks like, it's not very supportive. Those dots don't seem to be connected. And that's what I try to figure out with any outlook. How are those dots connecting? Where are we in the cycle and how to think about market behavior based on that? So many things you've said that I feel like I'm going to be able to tie back to later.

14:06Why don't we talk a little bit about 2025? What has happened? Where are we? Where is sentiment today? I feel obliged to point out something that I've heard you say a number of times as others, but basically that tops are a process, but bottoms happen pretty quickly. Where are we with 2025 done? I'm never a contrarian just to be a contrarian. But sometimes I feel like, really, everybody has this view and so do I. And that view is that this broadening out trade that we have already started to see kicked in the latter part of last year. I think that that has legs. That is the consensus, though. That doesn't mean I'm going to move away from that view simply because so many other people have that view.

14:47But I do think the inner workings of the market in a year like this are going to look a bit different than last year. Certainly the first, maybe call it two-thirds of last year. You had that mega cap bias. You had severe concentration. You had a very low percentage of stocks within an index like the S &P 500 outperforming the index itself. But you had such dominance, at least in the first half to two-thirds of the year, by the mega cap stocks and a cap-weighted index. It kept the market looking like it was fine. But the fuller, more complete story was told under the surface. So in a year like last year, where the S &P was up 16 percent calendar year 2025, it's actually 502 constituents in the S &P because two stocks have two shares.

15:39Google and Berkshire. Let's just call it 500 for simplicity stake. The average member in calendar year 25 had a maximum drawdown of 27%. Within the NASDAQ, the average member in calendar year 2025, in an environment where the NASDAQ was up 20 % at the index level, the average member had a maximum drawdown of 52%. It just happened through a process of rotation and churn under the surface. You had the indexes kept more than just afloat by virtue of the power of those mega cap names. Another lesson that comes in an environment like that, and I think this is an important shift that has started to happen in the latter part of 2025, and I think will persist in 2026, Six is that it really highlights the difference between a stock's contribution to index returns and a stock's price performance.

16:37I always use an example of this, which is NVIDIA, the poster child for everything AI, always the first stock we think of in the so-called Magnificent Seven. And last year, NVIDIA was the number one contributor to S &P 500 returns. but it was the 75th ranked stock in terms of price performance. It was the largest contributor because of the size. So contribution to capitalization-weighted index returns comes from price performance multiplied by the capitalization size. In other words, 74 stocks within the S &P 500 outperformed NVIDIA, even though it was the largest contributor. The reason why I always bring this up is because I think that there's this misperception.

17:27First of all, I think there's a conflating of contribution and price performance. I still hear people, well, the only way I can do well is to only own those names because they're the best performers. They're among the biggest contributors. They're not the best performers. and you don't have to take that concentration and bring it into your own portfolio and the risk associated with that because individual investors are not institutions. If you're a fund manager and you're benchmarked against the S &P 500 on a quarterly basis, you are at the mercy of the construction of the indexes. You have to have some semblance of similar size or you're going to underperform the index, but that's not an individual investor problem.

18:08But now we have a situation where last year, only two of the Magnificent Seven outperformed the S &P 500. You actually went old school. Two of the best performing stocks in the S &P were SanDisk and Western Digital, not brand new, hyped up AI related names. And I don't cover individual stocks. I mentioned names, but they're not recommendations one way or another. It's just to make the point that I think there's now going to be more opportunity that has presented itself in part because the average member within the S &P had a 27 percent drawdown at some point last year. I think that opportunity bred an appetite for where else can we find interesting ideas?

18:47I think that's a theme that started in the latter part of last year and I think will continue in 2026. It's a more level playing field for active managers relative to passive. It's a more level playing field for equal weight relative to cap weight. Not in a linear fashion, but I think it's going to be a more interesting year with more opportunity for investors to find interesting ideas outside of just these monolithic small little cohorts. I really appreciate that perspective. There's a chart that I often show people about what the performance of the top 10 largest S &P 500 stocks are up until the point they become top 10.

19:25And then what happens to the performance after they've made the top 10? And people just can't wrap their heads around how can that be that they really underperform on average the following five or 10 years? Law of large numbers. Absolutely. You started the comment with saying the broadening of performance that might mean to an investor who's more diversified in the mid-cap space or the small cap space or value and... International. International emerging markets obviously did really well in 2025. 25. As you mentioned, valuations are not a great timing tool, but they can act as a compass for any investors out there.

20:01And much of what your work does and the other work that I like to put in front of individual investors is, again, creating that perspective. In many ways, I'll admit that I just want to tell the story to get somebody to stay the course. But in general, I do think it's a really interesting trend, but also exciting just for anyone who is the diversified investor and who has felt like they've lost out the past decade plus. One quick quote I want to read from your 2026 outlook. You already said something like this at the start when you're talking about your process, but I really liked it. Quote, uncertainty generally assumes unknowns.

20:32Elections, wars, Federal Reserve decisions, etc. Stability stems from the inner workings of the system itself. And there's a large list of bullet points, tariffs, housing supply, labor supply, this goal, all these things. When you're looking to 2026, you've mentioned a few things like the trajectory of earnings, sentiment, valuation backdrop, what are you most focused on? Or maybe what's the thing that could have you shift your view fastest if it changes today? The outlook for earnings, which is the mother's milk of stock prices, it's obviously an important fundamental driver, not in lockstep by any means, but there are still healthy expectations for earnings growth and for profit margins to remain in very healthy territory.

21:18That would be an obvious problem, I think, if we were to find that now actually the bar has just been set too high. The opposite has been the story of the last couple of years, very much so in calendar year 2025, where by the time all was said and done, and we only have three quarters worth of actual earnings data because we won't get fourth quarter until another couple of weeks from now. When all was said and done in each of those three quarters, actual earnings had bested what the estimates were at the start of earnings season by about double. I'm not suggesting my base case is that the bar has been set too high, but I think that would represent a risk.

22:00An inflation problem really developing again, escalating, such that it put the Fed not only in a position to have to stop considering continuation of easier monetary policy, but actually potentially move to tightening policy. So none of these are my base case, but I'm also paid to assess risks and what could cause problems in the market. Those would be to top of my notice. I didn't say geopolitical crises. Not that I'm saying, hey, they don't matter. Turn off the news. That as well as being the most recent example. But they don't tend to have long lasting impact on the market. Although I had a funny retort that I got on social media in response to the report that we recently just wrote just on Monday that had a table in it about geopolitical crises in the past that had a military flavor to them and what the subsequent market action was.

22:55And someone came back and said, yeah, but you're conveniently not focusing on 2001 Afghanistan, and the market was still down 25 % a year later. And I thought there was maybe something else very market-related going on in 01, like the bursting of the internet bubble in a two-and-a-half-year bear market that I don't think you could thread directly to Afghanistan, but okay. That's the internet for you. That's the internet for you. That's social media for you. So I think those would be things that certainly could happen that would cause me to say, okay, we may be in rougher sailing here. So I have a pretty constructive view without trying to time the market.

23:37But as I already mentioned, with a different flavor to the market, more opportunity, whether it's down the cap spectrum into other sectors of the market, continued opportunities outside the US. For now, nothing has upset that. Of course, we're only seven days into the new year. Of course. And I should note, you're recording on January 7th. This will publish on January 14th. So a whole week, a lot of things can change in the world. A lot of things can change. I would hope that the world doesn't change too much. I may sound like a complete idiot by the time this airs, Peter. We're not going to have any questions that really timestamp you poorly.

24:16But I will say anytime I have clients or family or friends who are asking about certain headlines, I always ask them, well, how do you think that's going to impact earnings? Is that going to change the amount of Coca-Cola sold or the amount of pharmaceuticals sold? And earnings really is what over the long term is going to drive price. There's some fluctuation there. But a lot of people are paying attention to a number of things. You actually mentioned the Fed. That's something I want to touch on because I get a lot of listener questions. A rate cut is expected. A new Fed chair is expected. Talk to us a little bit about your thoughts around all things Federal Reserve right now.

24:48The needle almost literally moves on a day-to-day basis in terms of expectations for what the Fed will do next. Market-based expectations can be calculated by the most popular tool that is used and is easily accessible. If you know how to Google something, it's just the CME FedWatch tool. At any moment, it tells you what the probabilities are for the next meeting in terms of do they stay on hold? Do they cut? But that's a moving target. And because the Fed is in data dependency mode, not to mention the fact that we had such a lack of data during the government shutdown and we're just now starting to digest data that's coming in, those expectations are going to jump around.

25:32My guess is that the Fed is not as anxious to cut rates again here, in part due to still sticky inflation. And then the recent labor market report that was healthier than expected. In between when you and I are having this conversation and when this will actually post, there'll be a jobs report. So I'm not going to try to forecast what is going to happen there. That's OK. Everybody forgives you for not predicting the future. You're good. Thank you. But I think those will continue to be needle movers. And we have such a cacophony of Fed speakers now. That maybe is one of the most interesting things.

26:14I've often joked that the Federal Open Market Committee sometimes can be called the Federal Open Mouth Committee. There's just been more support, not just under Jerome Powell, but even under Janet Yellen. And it started to some degree under Ben Bernanke, which is unlike under the Greenspan days, just providing freedom to members and Fed governors and regional Fed presidents to express their views. And so many more platforms that that could be done with the Internet and social media. But I think what's interesting about Fed policy in this backdrop is that there's not a common thread here. You're seeing it in the last several Fed meetings where you've had more dissents, dissents in both directions.

26:57Which used to be so unusual. So unusual. And I think it's going to be more usual. You look at the so-called dots plot. So every other Fed meeting, there's an updated summary of economic projections, every member's perspective on where the unemployment rate is going to be, where the GDP is going to be, where inflation is going to be and where the Fed funds rate is going to be. the range of those expectations is wider than it typically is. And I think that is going to continue. So it's going to be a little bit trickier to try to gauge, OK, what's the Fed's next move? Because it's not just a function of the data, but a variety of opinions.