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Schwab's Sonders: Where Market Is Headed as Earnings Are ‘Killing It’

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What You Need to Know

  • Forward P/E forecasts are moving lower because earnings are strong, Sonders says.
  • She says it's too soon to tell how Biden's proposed tax changes will affect portfolios.
  • Sonders favors volatility-based rebalancing.

Liz Ann Sonders, chief investment strategist at Charles Schwab & Co., is “not freaked out” by current stock market valuations as some analysts and investors might be because earnings are moving higher.

In an recent interview with ThinkAdvisor, Sonders explained that as the earnings calendar moved from the fourth quarter of 2020 into the first quarter of 2021, the forward price-to-earnings ratio of the S&P 500 moved down from 27 to 22 because of the stronger denominator, the earnings — or as she put it, ”The denominators are just killing it.”

According to FactSet, of the one-quarter of S&P 500 companies that have reported earnings through April 23, 84% have reported a positive earnings surprise and 77% have reported a positive revenue surprise. If the 84% earnings beat stat continues to hold, it will be the highest percentage of companies reporting a positive earnings surprise since 2008, when FactSet began tracking the metric and when the percentage of companies reporting earnings surprise was also 84%.

On the Economy

Strong economic news is underpinning corporate earnings and stock prices. The 6.4% jump in first-quarter GDP left the U.S. economy within 1% of its peak, reached in late 2019, before the coronavirus pandemic hit. The report sent the S&P 500 to its second record high in four days, followed by a retrenchment on Friday.

The GDP surge was “great economic news,” Sonders said. “There’s nothing wrong about great economic news, but the rub is when you get into these extreme zones of improvement across quite a few standard economic measures like GDP, unemployment, ISM, consumer confidence, historically that is not accompanied by robust stock market performance.”

On Stock Market Leadership, Quality and Rebalancing 

In the meantime, leadership in the stock market is broadening well beyond the five big tech leaders — Facebook, Amazon, Apple, Netflix and Google — that prevailed until September 2020 and and into more high-quality cyclical companies after the flash-mob GameStop rallies earlier this year, said Sonders. “Since that started to fizzle at the end of February we’re back to a more fundamentally driven market” focused on “profitability and value,” she said.

“Quality needs to be a factor particularly for the individual stock picker,” said Sonders. She expects small-cap stocks will probably outperform large-caps in general and noted that the S&P SmallCap 600 index is a higher quality group of stocks than the Russell 2000, which is the standard benchmark for small-caps.

“This bull market will end, but it will have a correction first. The key is what you do along the way,” Sonders said. She recommends diversified portfolios and rebalancing based on market factors, not the calendar.

“Volatility gives you the ability to rebalance more frequently,” said Sonders. “Add low and trim high,” meaning add allocations to weaker performers and reduce the holdings of stronger ones. She calls this “volatility-based rebalancing.”

Sonders says its’ “too soon to know” how President Joe Biden’s proposed tax changes will affect portfolios.

On Inflation

Sonders sees more inflation in asset prices and the real economy but expects the latter will start to fade in June due to comparisons to to year-ago levels. Still, supply chain disruptions could be longer lasting in some industries and some companies will pass on price increases if the dollar is weak and commodity prices are high, said Sonders.

But she notes there is too much slack in the labor market and lack of money velocity to create 1970s-style inflation.

Outside of Work

Asked about books she’s reading now, Sonders says she enjoys rock biographies and is reading a new one on Steven Tyler of Aerosmith, but she has little time to read.

Sonders recommends The End Game, a podcast hosted by Grant Williams and Bill Fleckenstein, who together have spent about 70 years working in the financial markets. The overarching theme of the podcast, according to Sonders, is the endgame for reducing the deficit and getting out of debt, with guests who debate the issue such as economist Lacy Hunt, who’s focused on deflation and gold bugs.