Top analysts at Charles Schwab expect the Federal Reserve to cut interest rates not once, but potentially twice during the second half of the year.

“On Fed policy, we do expect one to two rates cuts in the second half of year,” Kathy Jones, Schwab managing director and chief fixed-income strategist, said during the company's mid-year outlook webcast today.

“The dot plots (economic performance data points) will make this a very close call, but as inflation comes down and growth accelerates, we expect the Fed to respond with cuts,” Jones said.

One indicator that Jones likes is the U.S. Bureau of Labor Statistics new tenant rent statistics. “Real-life rents have come down and we think that will continue as inflation comes down. Rents are almost flat in terms of increases,” she said.

On the bond front, Jones cautioned advisors against using Treasury bonds because of the inverted yield curve and said she prefers high-quality corporate bonds with longer durations of five to seven years.

Because of Schwab’s expectations that the Fed will cut rates, Jones advised that locking in bond deals on extended durations makes sense, but outside the the Treasury market.

“Instead of trying to lock in higher yields using Treasurys, we’re looking at investment-grade corporate bonds with yields that are paying close to or higher than 5%,” Jones said. “We think corporates are attractive five to seven years out. It’s time to extend duration, but when we look at yields, you can do it without taking on a lot of risk."

As for the U.S. dollar, “it does have some room to come down, but we don’t think the decline will be substantial enough to offset the [dollar] conversion risk of emerging market bonds,” Jones said.

Jones said municipal bonds can still make sense for investors in high tax states such as California, Hawaii and New York, but she warned that their popularity has led to compressed valuations.

Liz Ann Sonders, Schwab’s managing director and chief investment strategist, said she expects large-cap stocks to continue to do well in the second half, but said she would stick with companies that have higher earnings and valuations.

“Today it’s the companies with stronger balance sheets and stronger earnings that are continuing to do well,” Sonders said.

Performance is coming  less from the historically top-performing, so-called Significant 7 stocks and more from the Fabulous Four of Crowdstrike, Nividia, Shopify and Visa, she said. 

“Maybe it’s actually a market of one, given the obvious leader here,” Sonders said, referencing Nvidia’s 215% over the past year.

Because of the outperformance of a handful of stocks, “we have a concentration problem in indices,” she warned. “It’s a very low percentage of the S&P 500 that is outperforming the index. There is no way to know when this will change or to time trades around this, but be careful of concentration in the index funds you use."

“You can see the clear bias [for top-performers] in the first and second quarters of this year and then their accelerated pace of earnings growth. That will be to the continued benefit of the Fabulous Four’s earnings,” she said.

Sonders said it’s been a hard year for analysts to pin down. “If you had two strategists prognosticate at the beginning of the year and one said the market will outperform and really rip and the other said ‘I think it will get ugly,’ both would be right.”

Jeff Kleintop, managing director and chief global investment strategist at Schwab, said that countries around the world beginning a rate cutting cycle over the first half of the year and valuations up sets up a favorable outlook for global markets in the second half.

If inflation continues to decline, international small caps, which have been outperforming in Europe, may be a good addition to investor portfolios, he said.

What this means for investors is that both small and large caps may benefit. Small-cap stocks have been outperforming in Europe and European stocks are actually outperforming the S&P 500, Kleintop noted.

“It’s only by a narrow margin thanks to U.S. performance of the Magnificent Seven, but it’s been a full cycle since the last time Europe outperformed the U.S.” he said.

It’s likely that many investors have underweighted international socks, but it’s not too late to consider rebalancing into high-qualify international, he said. Many of the things investors favor right now, including earnings and profitability, are present in the international market right now, Kleintop added.