Q&A with Liz Ann Sonders: What’s Behind the Recent Market Volatility?
- Recent U.S. employment data has renewed the possibility of further Federal Reserve short-term interest rate increases.
- The stock market appears reasonably valued, and higher valuations are unlikely without a return to positive earnings growth.
- Some market participants have said low oil prices are sending a recessionary signal, but recessions historically have been preceded by oil price spikes, not crashes.
Global markets have been unusually volatile so far this year, including during the past few trading sessions. In light of the market's downward moves, we sat down with Liz Ann Sonders, Chief Investment Strategist for Charles Schwab & Co., to get her take on the recent market action and economic news.
The January U.S. employment report came out last Friday. Views on the data were mixed, with some apparently thinking the report renews the possibility of a Federal Reserve rate hike sooner rather than later this year. What was your take?
Liz Ann Sonders: The headline number was weak, but the underlying details were very strong.
The economy created 151,000 jobs in January—below expectations—while revisions shaved 2,000 jobs off the readings for November and December. However, the unemployment rate fell below 5%, a post-recession low, in spite of the fact that the labor force participation rate rose for a third consecutive month.
Household survey employment surged, with 25-to-34-year-olds making up the vast majority of people in new jobs. Part-time workers unable to find full-time work moved back toward a post-recession low. Finally, wages continued to rise, and hours worked were at a post-recession high.
It's still possible, and some would say likely, that the Fed will not hike rates again in March, but the data renewed the case for continued tightening—likely a primary reason for the market’s slide.
Let's turn to the U.S. stock market. Technology stocks are getting hit, some say due to steep valuations. What do you think about valuations?
LAS: There are a wide variety of valuation metrics, often saying conflicting things about whether the market's reasonably valued or not. My take is the market's fairly valued, but conditions don't exist for valuation expansion without stronger earnings growth.
We're in the midst of earnings season right now, with many companies reporting their financial results for the past quarter. How is it going and what do you expect the rest of the way?
LAS: The earnings "beat rate"—that is, the number of companies whose reported earnings beat expectations—is currently at 69%, the strongest since the third quarter of 2010. However, the revenue beat rate is still depressed at 46%. Materials, technology and health care have had the highest beat rates, with utilities exhibiting the lowest beat rate of the 10 equity sectors.
Over the past four weeks, analysts have raised earnings-per-share forecasts for 347 companies within the S&P Composite 1500®Index, but lowered them for 882 companies—the most negative reading since October 2011.
One important note: Earnings are likely to remain under pressure as long as deflationary winds keep blowing. Pricing power—which, of course, is affected by inflationary or deflationary trends—becomes increasingly important in a slow-growth environment, and one in which labor costs are rising.
Finally, annualized six-month forward earnings expectations for the S&P 500® Index remain in negative territory. This is why you hear talk of an "earnings recession." What’s import to realize is that earnings recessions often correspond to economic recessions, but not always.
In cases where earnings recessions didn’t correspond to economic recessions, what were some of the common characteristics?
LAS: The common characteristics of the past four earnings recessions dating back to the mid-1980s that were not accompanied by economic recessions were a surging U.S. dollar and/or plunging oil prices—both of which we've experienced recently. Clearly, the energy and manufacturing sectors are hurting, but ultimately the damage there should be offset by the benefit of lower oil prices to the consumption-oriented U.S. economy.
What's your take on investor sentiment?
LAS: Not just recently, but over the past several years, the volatility of investor sentiment has generally matched the market's volatility. Very little movement is needed on the downside, in terms of market performance, to turn sentiment extremely bearish.
One survey I look at is put out by the American Association of Individual Investors (AAII), and that survey recently hit an extreme of low bullishness, while bearishness had spiked. Bullishness, at the recent low, was the lowest since just after the market crash of 1987. Investors are extremely pessimistic—typically, or eventually, a contrarian signal.
You don't think a recession is on the horizon, but the recession drumbeat is getting louder. What's behind the noise?
LAS: Don't get me wrong—recession risk is elevated, just not glaring yet. Although the U.S. economy remains bifurcated—manufacturing is in recession, but services are hanging in there—talk of recession got louder after the latest reading from the Institute of Supply Management on services came in weaker than expected.
Many suggest the weakness in oil is sending a recession signal. However, it has always been the case historically that spikes in oil prices, not crashes, preceded recessions. It would be unprecedented to have cheaper oil "cause" a recession. The energy and manufacturing sectors have taken it significantly on the chin, but energy sector employment represents only 0.5% of total employment and energy sector capital spending (capex) represents only 4% of total capex. Manufacturing in the aggregate is only 12% of the U.S. economy.
Market-based measures of the economy—for instance, yield spreads, the shape of the yield curve and stock market prices—are sending louder recession signals, while high-frequency economic-data-based leading indicators—like unemployment claims and some housing-based data—are not yet waving a red flag. Overall, the leading economic indicators have not rolled over to the extent typically seen before recessions.
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Past performance is no guarantee of future results and the opinions presented cannot be viewed as an indicator of future performance.
The S&P Composite 1500® Index combines three leading indexes, the S&P 500®, the S&P MidCap 400®, and the S&P SmallCap 600® to cover approximately 90% of U.S. market capitalization.
The S&P 500 Index is a market-capitalization-weighted index comprising 500 widely traded stocks chosen for market size, liquidity and industry group representation.
The AAII (American Association of Individual Investors) Investor Sentiment Survey measures the percentage of individual investors who are bullish, bearish, and neutral on the stock market for the next six months; individuals are polled from the ranks of the AAII membership on a weekly basis.