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Liz Ann Sonders: We May Already Be in a Recession

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Market volatility is likely going to continue to be high and the next potential driver of it may be the second-quarter earnings season, according to Liz Ann Sonders, managing director and chief investment strategist at Charles Schwab & Co.

While many economists and other market experts predict a recession may start in the U.S. this year or 2023, Sonders argues we may already be in one, based on how the National Bureau of Economic Research calculates the starting month of a recession.

Via email, we asked Sonders a few questions about the state of the market and where she thinks it’s headed.

1. What’s your view on where volatility is headed in Q3 and Q4 and why? 

Liz Ann Sonders: Volatility is likely to remain high, with bouts of extremes (in both directions). The next potential volatility-driver could be second quarter earnings season, with the expectations bar likely set too high (a stark difference relative to the past two years’ worth of high quarterly beat rates).

The Fed will remain a volatility-driver as well; and assuming labor market data weakens, aggressive monetary policy will highlight the Fed’s tunnel vision with regard to its inflation mandate at the expense of its employment mandate.

2. What are the greatest risks and opportunities for investors in this environment and why?

A key “known” risk continues to be an aggressive Fed; especially the risk that it tightens too much into an already-weak economy. Given the Fed’s heightened focus on inflation expectations, which are more tied than usual to energy prices, the Fed is increasingly getting criticized for targeting headline inflation.

Monetary policy is a blunt tool which can only tackle aggregate demand, leaving the supply side of the economy to adjust based on external forces.

3. What chance of a recession do you think there is today and why, and to what extent has the (equity) market already discounted a recession?

Not only is recession risk high, based on how the NBER dates their start months, it’s possible we are already in one. Once the NBER’s Business Cycle Dating Committee declares a recession as being underway, they go back to the peak in the aggregate data they track (primarily the four components of the Coincident Economic Index: payrolls, industrial production, personal income and business sales).

The stock market has never been this weak over this span of time without a recession either arriving in short order, or already underway. The consumer is under increasing pressure due to negative real incomes/wages, higher mortgage rates, rampant inflation and some “pent-down” demand, while businesses’ investment plans [are] weakening under the weight of uncertainty.

The weakness in the stock market does discount very weak growth (and perhaps even a mild recession); but doesn’t yet discount the coming pressure on earnings.

4. Do you think the markets are oversold, and where do you see the major indexes ending 2022 (Dow, S&P, Nasdaq) and why?

We do not do year-end price targets; and frankly, think that is a somewhat-useless exercise, especially given the individual investor profile of Schwab’s client base.

The market was quite oversold around the mid-June low; but the set up for/characteristics of the rally still smack of short-term counter-trend move in an ongoing bear market. Attitudinal measures of investor sentiment did reflect despair at the recent lows; however, behavioral measures suggest we have not hit the “puke” phase of rampant capitulation.

The estimated $170 billion of inflows into equity funds this year suggest investors are less despairing than survey-based sentiment measures would suggest.

5. What should advisors be telling clients at midyear?

This is not a time to take on excess risk in portfolios. We continue to recommend that investors consider volatility-based rebalancing strategies vs. calendar-based rebalancing. Shorter-term, we have more of a bias to trim into strength vs. adding into weakness (although in the case of the latter, for longer time horizon investors, using weakness to bring equity allocations back to strategic weights makes sense).

We continue to recommend quality wrapping around factors — believing a factor-based strategy makes more sense than either a sector-based or style index-based strategy. Factors we favor have a blend of value and growth, including strong free cash flow, healthy balance sheets (low debt/high cash), positive earnings revisions and low volatility.


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