Bullish corporate earnings forecasts for 2018 could very well be individual investors’ biggest source of trip-ups, Charles Schwab’s chief investment strategist Liz Ann Sonders tells ThinkAdvisor in an interview.
“Curb your enthusiasm” and do not count on highly optimistic 2018 earnings growth expectations to necessarily continue into 2019 and 2020, warns Sonders, a popular industry keynote speaker and frequent commentator on CNBC, Fox Business News and CNN.
Equity investors’ “biggest mistakes” occur when they bet wrong based on the corporate earnings outlook, says Sonders. She has been with Schwab since 2000, when the firm acquired U.S. Trust, which she joined a year earlier as a managing director and member of its Investment Policy Committee. (Schwab sold U.S. Trust to Bank of America in 2007.)
The country’s largest publicly traded investment services firm since 2015, Schwab had $3.48 trillion in client assets under management as of the end of January.
For the year ahead, Sonders predicts more market corrections, higher inflation and tighter monetary policy. In the interview, she argues that the Federal Reserve will raise interest rates more frequently in 2018, even in the face of higher market volatility and pullbacks.
Long term, her biggest worry is the federal deficit, and she explains what the government must do to substantially reduce it — or suffer the inevitable consequences.
ThinkAdvisor recently talked with Sonders, on the phone from Florida, where she was visiting Schwab’s Naples office. She discussed a disturbing cause of last month’s market correction — among others — but why she sees such upsets as “healthy” for investors. The strategist also elaborated on the three market sectors she believes will outperform this year as well as the three she pegs to underperform. Here are excerpts from our conversation:
What’s your outlook for corporate earnings this year?
Last October, earnings estimates for 2018 year-over-year were about 11% [growth]. Now it’s 19.2%. We’ve never had such a sharp acceleration. And that’s largely courtesy of the tax cut. The concern I have is that if analysts or investors establish a permanently higher plateau of expectation and extrapolate, and assume that kind of growth for 2019 and 2020, there could be disappointment.
I think investors make their biggest mistakes when it comes to tying together corporate earnings’ fundamentals and what the stock market is doing. I tell investors: “If your level of enthusiasm just ramped up because we’re approaching 20% earnings growth, you may want to curb that enthusiasm because at some point, the market is going to sniff out the eventual turn.”
In January, you said that you wouldn’t mind seeing “some healthy pullbacks” in the market. Please elaborate.
That’s because in January, we started to see the market look melt-up-like. If melt-ups continue to go on, they tend to be followed by meltdowns, much like what happened in 2000. In contrast, when the market is moving with fundamentals, has a normal pace of pullbacks or corrections and sentiment is in check, it’s a better long-term environment.
Do you foresee further corrections this year?
I think we could have more bouts like [the February correction] as we see some of the money and vehicles that have been tied to volatility’s staying suppressed forced [now] to unwind as we move back into what is a more normal environment. The lack of volatility was an exception. The return of volatility is more the rule.
Are you saying that corrections, net-net, are a positive for the market?
Yes. They’re painful, but they remind investors that markets don’t go up forever. I think that’s something healthy. And [corrections] also may be [showing] a change in character [in the market] and be a further indication that we’re later in this cycle.
What’s significantly different about the economy and stock market now vs. a year ago?
We’re in the later stages of the economic cycle with a pickup in inflation and are likely to get tighter monetary policy and more market volatility.
What are the risks of current monetary policy?
Several things have been unique about this cycle. One: We had the fed taking interest rates to zero. Then it started the quantitative-easing programs — never done before. Now the Fed is starting to unwind its securities holdings of $4.5 trillion. We’re backing away from that unprecedented stimulus.
What could all that mean to the market in the future?
We’ve gone from one uncharted territory into a different kind of uncharted territory. Most past episodes of volatility, late-cycle corrections and then a bear market — which we’ll get eventually — have been caused by tighter monetary policy. It looks different this time because we’ve never come off zero interest rates, and we’ve never shrunk a $4.5 trillion balance sheet.
Do you see a bubble about to burst or a meltdown on the horizon?
I don’t think we have a broad bubble that could take down the entire global financial system, a la the tech or the housing bubbles. There are some mini bubbles, however. But they don’t have massive leverage tied into them, and the counterparty [default] risk is nowhere as significant as in the tech or the housing bubbles. These aren’t going to cause trouble like a spike in volatility.
What approach do you expect from Fed Chair Jerome Powell this year?
If the Fed shocks anybody, then they just haven’t been paying attention. I think he’s going to maintain not just a lot of what Janet Yellen put in place but Ben Bernanke too, which is that transparency will stay high.
Can you talk specifics?
I believe that the Fed is going to raise interest rates at a more steady pace than has been the case in the last couple of years because the data will [likely] warrant it — growth going up at a higher trajectory, the output gap having closed, the labor market tightened sufficiently so that we’re now getting wage growth.
Why didn’t Yellen and Bernanke raise rates more often?
For the last eight years or so, the Fed [policy was] that if there was any kind of volatility or turmoil, they didn’t want it to morph into an economic problem. So they stepped off the brake pretty quickly.
And for this year?
I don’t think we’ll see that as much. The Fed is going to be more tolerant of higher volatility in both the equity and fixed income markets and also more tolerant of more frequent pullbacks. I think they see themselves on a path where rate hikes are going to be a bit more frequent than has been the case [in the recent past].
Is such tolerance a good thing?