Liz Ann Sonders: Don’t Fear a Recession or Market Overvaluation
This article is part of our Schwab IMPACT 2016 Special Coverage this week. More articles are listed below.
A recession is not imminent and investors should be skeptical of those who claim the market is vastly overvalued, according to Liz Ann Sonders.
Sonders is a senior vice president and chief investment strategist for Charles Schwab & Co., Inc. She was one of the opening night keynote speakers at this year’s Schwab IMPACT Conference, held in San Diego.
Approximately 2,000 advisors were registered to attend the conference, the largest in the industry.
Sonders cited a famous quote by Sir John Templeton, “Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria.”
She offered her own version: “This bull market was born on despair, grew on disbelief, is maturing on skepticism and may die on acceptance.”
According to Sonders, the bull market is still maturing and the prospects for capital growth are intact.
Sonders acknowledged that a recession is a key risk that could trigger a downward move in stock prices, but she said that a recession is unlikely and that the most likely scenario is that the economy will “muddle through” in 2017.
I’ll review Sonders’ comments on the economy and some of the other risks she foresees.
Monetary policy-driven risks
Sonders said that market volatility has been driven by central bank policies – particularly those of the Fed. There is a growing acceptance, she said, that markets and economies will face some of the side effects of zero interest rates and quantitative easing.
She identified some of the perils of unprecedented monetary policy: depressed interest income, yield chasing, unhealthy companies being propped up, and healthy companies buying back their stock and not investing in capital expenditures.
She said the most important consequence is asset-price inflation: equity and fixed income asset classes are up 25% to 250% versus “real economy” price increases, which have been far smaller. This has led to a “massive spread” between the benefits to investors and the real economy, Sonders said, and has fueled debate over income inequality.
Another consequence is that household net worth has grown faster than nominal GDP during the post-crisis period. The gap between the two is similar to 2007, and according to Sonders “this is a macro risk.”
She added that “the Fed has limited its power in case of trouble” by keeping interest rates so low. She said this leaves it in a position where it must resort to quantitative easing if an economic contraction occurs.
Where are we in the cycle?
Is a recession on the horizon? “We don’t think so,” Sonders said, “but the risks have risen mildly.”
Sonders provided data on a number of leading-economic indicators (LEIs), which she said have not “rolled over.” A recession would be “unprecedented” if it were to happen under current circumstances, she said. The only LEI that is worsening is the average workweek, and Sonders downplayed its significance.
She said she follows a recession model by Cornerstone Macro and its shows a 36% risk of recession –“not yet flashing a warning,” according to Sonders.
Inflation is picking up, she said. The core PCE and CPI indicators are 1.7% and 2.3%, respectively. The difference between the two is in housing and health-care inflation, which are rising faster and have a larger representation in the CPI than the PCE.