Excess Returns Podcast — Episode Summary

Episode Title: The Great Moderation Is Over | Liz Ann Sonders on What Replaces It
Guest: Liz Ann Sonders (Chief Investment Strategist, Charles Schwab)
Date: January 14, 2026
Hosts: Jack Forehand, Justin Carbonneau, Matt Zeigler

Episode Overview

In this episode, Liz Ann Sonders returns to Excess Returns to discuss the end of the "Great Moderation"—the multi-decade period of relative economic stability marked by steady growth, low inflation, and subdued volatility. Sonders examines what comes next, emphasizing a new era characterized by instability, economic bifurcations, and rolling recessions. The conversation delves into market breadth, the impact of AI, labor market crosscurrents, changing inflation dynamics, and how investors can navigate these persistent uncertainties.

Key Discussion Points & Insights

1. Instability vs. Uncertainty: The New Macro Backdrop

• Instability, Not Just Uncertainty:
  Sonders distinguishes between uncertainty (a market constant) and instability (the new defining feature), arguing this era is marked by policy, monetary, and geopolitical instability, resulting in a persistently “K-shaped” recovery.

  “It’s this instability that makes this cycle a little bit different...I’m not sure that eases anytime soon.” — Liz Ann Sonders [00:45]

• Policy Volatility:
  Rapid shifts and knee-jerk political or monetary decisions further exaggerate instability.

2. The K-Shaped Economy: Bifurcations and Their Drivers

• Widening Gaps:
  Disparities between high and low income consumers are stark—assets (and recent appreciation) accrue disproportionately to higher earners, while low-income groups bear the brunt of sticky inflation in essentials.
• Sector Divergences:
  Services sectors (healthcare, education, hospitality) drive job growth; manufacturing lags.
• Inflation Impacts:
  Inflation bifurcates between discretionary (“wants”) and non-discretionary (“needs”) goods, hurting lower-income households.

  “I don’t think 2026 is going to be a year where we revert to some sort of normal looking cycle as it relates to those divergences.” — Liz Ann Sonders [04:42]

• Market Breadth Improves:
  Suggests continued, though uneven, broadening beyond mega-cap tech leaders; sees outperformance in small caps, equal weight indices, and international equities.

3. Data Quality and Economic Readings

• Declining Data Reliability:
  More economic/labor indicators now imputed (estimated) due to low survey response rates and government shutdowns, leading to greater reliance on alternative data (e.g., ADP, non-government sources).

  “Parallel sources of data have come more into the spotlight...as a bit of a check and balance to the official data.” — Liz Ann Sonders [10:29]

4. Inflation Dynamics: The Floor Has Moved

• From Great Moderation to “Temperamental Era”:
  Forces that kept inflation low (globalization, shale energy boom) are fading; new environment is more volatile and unpredictable.
• 2% Target as Floor, Not Ceiling:
  Where 2% was once the upper bound for inflation, it may now form the lower bound.

  “For much of the great moderation, you could almost think of 2% as the ceiling in the range. Now I think we may want to think of 2% as the floor in the range.” — Liz Ann Sonders [13:04]

• Fed’s Challenge:
  Inflation swings complicate policy, with current conditions echoing the “temperamental” decades of the 1960s-90s.

5. Labor Market: Headwinds, Tailwinds, AI Influence

• Mixed Labor Picture:
  Extremely low layoffs (tailwind), but sluggish hiring and rising continuing claims (headwind). Immigration slowdown crimping labor force growth, making productivity crucial for economic expansion.
• AI’s Impact:
  Early evidence that AI is automating tasks (not full jobs); may reduce the need for entry-level/grunt work, possibly affecting young workers.

  “At this stage AI is a replacement of task, not really a replacement of occupations. And I think that’s an important distinction.” — Liz Ann Sonders [21:54]

• Productivity Gains:
  Surging productivity statistics partly offset tight labor supply.

6. Sentiment: Negativity Gap and Behavioral Paradoxes

• Persistent Pessimism Despite Good Data:
  Hard “real” data (markets, GDP) are robust, but sentiment surveys (soft data) are gloomy—a disconnect amplified by negative media, social media rabbit holes, and shifting investor types (rise of retail traders focused on short-term, “FOMO” trading).
• Behavior vs. Attitude Gap:
  Investors may claim bearish sentiment (record number of AAII “bears” in June 2022), yet keep equity allocations near highs.

  “At that time of a record high percentage of bears, equity exposure was only 1% off an all-time high. A perfect example of what they’re saying and what they’re doing are entirely different things.” — Liz Ann Sonders [26:01]

7. Rolling Recessions and Economic Rotation

• COVID as Catalyst:
  Explains how lockdown-induced abrupt stops/starts in different sectors have led to rolling mini-recessions rather than typical cyclical ones.
• Sectoral Corrective Phases:
  Market drawdowns are often sector-rotation driven, not broad-based collapses (e.g., Mag 7 to “Lag 5 and Mag 2”).
• Tech’s Unique Role:
  Tech’s lower cyclical sensitivity means sectoral bear markets can occur beneath broad market advances.

8. Fed’s Bind: No Clear Roadmap

• Monetary Policy Caught Between Mandates:
  Inflation and labor data send mixed and rapidly shifting signals; Fed is “wedged between a rock and a sign that says Hard Place.” [41:40]
• Factionalism Within Fed:
  Growing dissent among FOMC members about the direction of policy—both toward ease and tightening.

9. AI-Driven Capex: Bubble Echoes?

• Not Quite 1999:
  The scale and demand-driven nature of current tech/AI capital spending differs from the late-90s dotcom bubble. Spending is mostly earnings/cashflow financed, though some risk from growing debt issuance.
• Valuations & Corrections:
  Tech valuations remain stretched, but broadening out and sectoral rotations make a sudden crash less likely.

  “Notice I didn’t use the other B word, bubble. I think that we may be still a little bit too early to declare that this might be more of a 1997 kind of environment than a 1999.” — Liz Ann Sonders [46:40]

10. Positioning for the New Era: Factors Over Sectors

• Adopt Factor-Based Investing:
  Favors growth at a reasonable price (GARP): mix of positive earnings revisions, stable or growing margins, sound balance sheets, and reasonable valuations across the style/cap/sector spectrum.

  “I think it’s not about areas, it’s more about factors. So I think for now anyway, gone are the days of being able to make monolithic investment decisions.” — Liz Ann Sonders [56:54]

• Diversification Is Back:
  Breadth and dispersion favor disciplined, diversified, and factor-oriented approaches—less sector or theme chasing.

Notable Quotes & Memorable Moments

• On Secular Shifts:

  “For much of the great moderation, you could almost think of 2% as the ceiling in the range. Now I think we may want to think of 2% as the floor in the range.” — [13:04]

• On Investor Sentiment Paradox:

  “At that time of a record high percentage of bears, equity exposure was only 1% off an all-time high.” — [26:01]

• On AI’s Role in Labor:

  “At this stage AI is a replacement of task, not really a replacement of occupations.” — [21:54]

• On Fed’s Dilemma:

  “It was sort of a mixed metaphor cartoon. I thought, I want to have Jerome Powell sitting in a car that's shaped like a pickle, but it’s wedged between a rock and a sign that says Hard Place.” — [41:40]

• On Market Breadth and Diversification:

  “Now you have the ability to say you’re welcome a little bit more often...I am optimistic that this broadening out could persist.” — [07:40]

• On Valuation as a Timing Tool:

  “Valuation is just a terrible market timing tool. There isn’t a great market timing tool. If there was, I’d have it.” — [55:44]

Timestamps for Key Segments

• Instability vs. Uncertainty — The Cycle Is Different: [00:45–04:19]
• Understanding the K-Shaped Bifurcation: [04:19–07:40]
• Market Breadth: Broadening Out Trade: [07:40–10:02]
• Data Input & Quality Issues, Rise of Alternative Sources: [10:02–12:41]
• Inflation’s New Secular Range: [13:04–16:26]
• Stock-Bond Correlation Shift: [16:26–17:15]
• Labor Market Crosscurrents, AI’s Effect: [18:46–21:54]
• AI's Economic Impact & Three Cs (Create, Catalyze, Cultivate): [21:54–24:19]
• Sentiment Paradox – Attitudes vs. Behavior: [25:43–31:36]
• Rolling Recessions, Tariffs, and Economic Rotation: [32:40–39:17]
• Fed’s Predicament – Policy Tightrope: [41:29–44:51]
• AI Capex Boom – Bubble Comparisons: [44:51–51:31]
• S&P Earnings & Valuation Dynamics: [52:17–55:44]
• Smart Allocation: Factor-Based Investing: [56:21–59:32]

Conclusion

Liz Ann Sonders presents a sobering yet practical roadmap for investors facing a post-Great Moderation world: expect more volatility, instability, and economic divergence—but also more opportunities for active, factor-driven, globally diversified investors. Discarding the pursuit of certainty, she champions discipline, adaptability, and a keen eye for what’s truly driving both hard economic outcomes and the ever-elusive market sentiment.