There is “ even more pain [ in the markets ] under the surface of the indexes .”
— Liz Ann Sonders Chief Investment Strategist , Schwab the Fed attempts to tighten monetary policy to cool economic activity off . What markets may be about to see in July is a shift in phases to a lower trajectory for corporate earnings and profit margins . The Fed may have a dual mandate of maintaining price stability and healthy levels of employment , but with unemployment at 3.7 %, circumstances require the central bank to focus almost solely on runaway inflation .
Sonders told attendees that there is “ even more pain [ in the markets ] under the surface of the indexes .” The upshot is that “ we haven ’ t gotten to the point ” of capitulation .
She said she didn ’ t expect volatility to diminish . Instead , she told advisors to be on the lookout for “ a full market washout ,” even though it may never come .
Asked to compare the current wave of inflation to either the 1970s or the 1940s , Sonders said the price behavior in the post-World War II era is a more accurate parallel . That ’ s because “ a lot of the drivers are somewhat similar to what we experienced post-lockdown .”
The wave of stimulus during the Covid-19 pandemic “ put a tremendous amount of money in the hands of individuals and businesses .” Initially , most of it went to the “ good side of the economy ,” partly because people had “ no access ” to spend money on frivolous activities .
The 1970s had a “ lot of dissimilar drivers ,” in her view . Chief among them were deteriorating labor-market conditions . In the 1970s , tens of millions of baby boomers entered the market , a sharp contrast to today when those same folks are retiring .
Instead , it ’ s the supply-chain shocks of the 1940s that offer the most glaring similarities to today ’ s economic landscape . But there were demographic differences between the post-World War II period and today , and disparate structural conditions as well — the unionization movement back then was far more ubiquitous than a few Apple and Starbucks outlets .
Unfortunately , a recession is a higher probability than a soft landing , by Sonders ’ estimates . In any Fed tightening cycle , “ the needle always points more towards a recession than a soft landing .”
This time , there are a confluence of factors . The central bank is not only tightening ; it ’ s also trying to shrink a $ 9 trillion balance sheet . “ It ’ s possible we are already in a recession ,” Sonders said .
Of the 13 Fed tightening cycles after World War II , only three have ended with a soft landing , Sonders noted . The first occurred in the mid-1960s , when the aggressive fiscal policy behind the Great Society programs and the Vietnam War helped propel the economy . Ultimately , these twin drivers helped spawn the inflation of the 1970s .
Sonders also noted that the soft landing in the mid-1980s occurred after a nasty double-dip recession , which began in 1970 and ended in 1982 , expunged many excesses from the economy . Finally , the 1994 landing coincided with the advent of the internet , which allowed businesses to slash costs even as it produced the high-tech stock bubble that burst in 2000 . Like the 2009-2020 bull market in stocks , the dot-com era did not generate a significant inflation in goods and services — only in financial assets .
Optimists point to the buoyant labor market as a possible signal that the
economy can sidestep a recession . However , Sonders noted that unemployment claims are already ticking up — and that the jobless rate is a lagging indicator .
She urged advisors to focus on signals like hiring freezes , reductions in job openings and layoffs as “ initial feeders ” to a recession . A real key could be a letup in both supply chain bottlenecks and the labor market . Conceivably , that could prompt the Fed “ to take their foot off the brake ,” she said , as it would free up bottlenecks in the economy .
Sonders suspects , however , this could be wishful thinking . “ If we are in a recession , the labor market will deteriorate ,” she predicted . Moreover , there has never been “ this big a drawdown in the equity market without a recession ,” she declared .
In the 21 months from late March 2020 through late 2021 , the Standard & Poor ’ s 500 and other stock market indexes doubled . Historical incidents of equity price appreciation at this rate are few .
Asked if this signals that markets were in a bubble last year , Sonders responded that many sectors of the stock market and other investment vehicles exhibited “ micro bubbles .” She pointed to crypto currencies , “ SPACs , heavily shorted stocks and meme stocks ” as clear-cut examples of this phenomenon .
As market strategist for the nation ’ s largest discount broker , Sonders has been an avid student of investor sentiment . The outlook for equities , when measured by the University of Michigan consumer survey , is at an all-time low .
Sonders warned advisors that investor sentiment was hardly “ a perfect timing indicator .” However , if investors remain increasingly negative , it ultimately could have a positive effect on stock prices . After all , consumers and the public at large have often despised stocks at the start of many extended bull markets . At the same time , this isn ’ t 2009 . Sonders told attendees how she received one of the great buy signals of her life at a dinner party in March 2009 . On the Friday night before March 9 of that year , she and her husband attended a party filled with gloomy Wall Streeters .
18 | financial advisor magazine | july / august 2022 www . fa-mag . com