On Aug. 29, 2013, I had a phone interview with Liz Ann Sonders, senior vice president, chief investment strategist, with Charles Schwab & Co., Inc. Liz Ann is one of the most respected authorities on equities in the world, and quite often has the most prescient market commentary being published - at a great price. Free. So, get to know Liz Ann more in the interview below. And be sure to subscribe to her ongoing market commentary at Schwab.com.
What is your general view of Wall Street today? We've had a magnificent year, with the Dow Jones Industrial Average posting gains of up to 19 percent. And then the tide turned for a miserable August. What's next?
We're in a tough environment right now. I put a note out a couple of weeks ago that I entitled, "Pause." I thought that the market was due for a breather. Sentiment had gotten quite elevated in terms of optimism. There was some technical deterioration. You had the big uncertainties of the upcoming Fed Meeting and the possibility of tapering and the implications of that. The Debt Ceiling fight, which looms. The sequestration Round 2 spending cuts kicking in on October 1st. The uncertainty on the Affordable Care Act. You add Syria into the mix and the pickup in energy prices, which hits consumer confidence. On top of that, you have seasonal weakness that tends to kick in this time of the year. So, you put all of those in a pot, stir them up and that suggests a bit of a tough environment for the market. We're down close to 5 percent. Whether that is enough... We're not in a position to time every wiggle in the market, making calls on what size the drop will be, but something maybe south of a full-on correction, which would be double-digits, is, I think, in the cards.
How does Syria play into the mix?
Syria is one of those exogenous things, and it is tough to judge the implications. Military events that tend to be short-lived, like this one might be, have actually proven to be phenomenal buying opportunities. So, that could be the case this time, too, and it could be at the right timing for some of these other things to settle out.
Given that you have a short-term "pause" view of Wall Street, are you ultimately bullish or bearish on U.S. stocks? Wall Street has been one of the best investments since the March 2009 lows. NASDAQ has more than doubled. Can this pace continue?
Medium to longer term, I'm still quite optimistic. Valuation is still quite reasonable. Probably the biggest reason for my optimism is that we have not made a dent at all in the long-term Wall of Worry. There is really no cohort yet, whether it is individual investors, or hedge funds, or traditional pension funds, or endowment foundations, that has fallen in love with equities again. There is still a tremendous amount of skepticism and pain from the financial crisis and a view that we are still in a secular bear market. I don't think we've gotten anywhere near the kind of enthusiasm that tends to accompany latter stages of a bull market. So, near term caution, but still quite optimistic about the longer term.
Do you think that the Bond Exodus, if that starts to pick up some more, will push people into equities?
There hasn't yet been what is called The Great Rotation. We are looking at record outflows in bond funds, and we're seeing a renewed interest in equity funds, but it's not really the same money. A lot of the money that has been leaving bonds has been going into cash.
The World Gold Council is reporting a record demand for gold bars and coins in the 2nd quarter of 2013, equaling $23.1 billion. Are people more interested in hard assets than stocks or bonds?
Endowments and foundations -- as probably the biggest cohort of the institutional community -- their equity exposure has gone down by about 10 percentage points in the last ten years or so. The biggest place where that money has gone, and I think you'd find this with high net worth investors, too, has been into "alternatives" -- commodities, including precious metals, and hedge funds. Hedge funds, lately, really post-financial crisis, have been underperforming traditional equities. Now you throw in problems in commodities and the carnage of many commodities and precious metals and foreign market currencies. [That is] probably making some of that money wonder, "Hmmm. Should I be paying this premium, from a risk perspective now, and from a fee perspective, when I look at the performance of traditional index funds?" The SPDR ETF is doing quite well. I think that's an opportunity that is underappreciated in terms of where volume and flow [into stocks] could come from.
You've issued an alert to "Avoid China," and are bearish on emerging markets right now. Why?
The problems in China, India and Brazil are secular, and not just a short-term cyclical problem. When people look at underperformance, particularly the carnage this year in those areas, they think it's a short-term problem because look at the growth rates. There is still this muscle memory thing that emerging markets are where all of the growth and opportunity are. But we think the shift, which has actually been underway for several years now, where the U.S. has been outperforming, is not just a short-term phenomenon, but is more long lasting. And outside of the U.S., the better opportunities are in the developed part of the world, maybe Europe, and to a lesser degree, Japan.
The developed world, including the U.S., has an enormous amount of debt. Are you concerned about our $16 trillion debt, or how the PIIGS* problems affect Europe?
I'm very concerned about that. We think that we may have hit an inflection point. We've seen the U.S. budget deficit go from ten and a half percent of GDP to four percent of GDP in a much faster frame of time than anybody could have thought. The sequester forced spending cuts that probably wouldn't have happened if the government's hand wasn't forced. There was a pickup on the revenue side, which was a combination of tax rates going up, but also because the economy has done better. There is enough growth in the private sector to offset the fiscal drag. And that is the important message that is coming out this year, and should be the message going to politicians. The Sequester is not going to plunge the economy back into a recession. The private sector has enough growth and they are far enough along in their deleveraging to allow the public sector deleveraging to begin.
So, you're not overly concerned about the second round of sequester spending cuts?
Sure, if we just threw money at this, the economy would grow faster, if all engines were firing, including government. But then you just make a debt problem even bigger down the road. So, rip the band-aid off. Start the process. If you can do it without tanking the economy, then you do it, even if it means that you sacrifice strong economic growth and have to suffer through a "fairly" low pace of growth. What's important to note, is that since the recession ended, the private sector has grown at a 3.1% average real GDP growth rate, versus a 2.1 percent for the overall economy. Now 2.1 percent is stall speed, the new normal, but 3.1 percent is actually pretty close to a norm rate of growth.
So, bottom line. Is it your view that the developed world is emerging, while the emerging economies are problematic?
A lot of people think of the U.S. as, to use one of my friend Bill Gross' terms, "the cleanest shirt in a pile of dirty laundry." I think it's not just the U.S. looks okay relative to other areas. I think the U.S. looks pretty good here. The U.S. is the best relative play right now from a global/macro perspective. The mistake that investors make is that they don't understand the power of rate of change, of inflection points. The market tends to launch from that turn. But, by definition, at the inflection point, on the downside when you turn back up, the numbers are horrible. You are at the low point. Yet that's where the greatest opportunities come for investors. I also think that what started back in March of 2009 for the U.S. market was not just a cyclical bull in an ongoing bear market. I think that what started in March of 2009 was the beginning of the next secular bull market that we are in the middle of right now.
Thank you, Liz Ann, for your keen insight and valuable wisdom and data into today's markets.
*PIIGS: Portugal, Ireland, Italy, Greece and Spain.