Schwab's Sonders: Investors Are Complacent on Big Stock Risks

While strategists regularly issue full-year and midyear outlooks, "the market frankly doesn't care about calendar year-end and midyear point," and Schwab avoids year-end price targets, which Sonders considers "an absurd exercise."

The strategist sees complacency about numerous points, including the market's view that "well, the war will be over very soon. And I don't know where that view is coming from because notwithstanding the pronouncements that it will be over soon, it has not been over soon," she said.

Sonders noted comments this week from both Exxon and Chevron saying that inventories have been drawn down significantly, which has near-term implications for oil prices. "Both of them came out and said, 'We could see oil prices jump by another 50 bucks in short order.' And I don't think that's priced into the market."

AI Reality Check

Sonders also sees potential complacency related to the AI buildout, given possible obstacles on both the supply and demand sides.

Broadcom shares dropped about 12% on Thursday after its AI chip sales forecast disappointed investors. The stock fell another 6.5% as of mid-afternoon Friday.

"We're seeing that to some degree in market action as it relates to what Broadcom announced, that what we may be experiencing is an expectations bar that even if not set too high, the margin for error, the margin for disappointment is narrower. And I think you could have quicker sort of knee-jerk reactions to any kind of throwing water on the fire of the AI spend story," she said.

Broadcom's news won't drag down the bull market on its own, "but if we get more of that, and it wouldn't just be individual companies coming out and either reporting slightly weaker numbers or making a comment about the sales outlook, it could also be the increasing problems from a supply chain standpoint that hindrances to the AI buildout might not be just about the demand side, but the supply side. And we are starting to see that," she added.

That could include potential supply constraints related to the ongoing Strait of Hormuz closure, which may affect materials like helium that go into semiconductors, and also feed into inflation, Sonders explained. There's also a problem with the inability to produce supply to keep pace with demand, she said.

"So the inflation story has been very much an energy story, but now there's an AI story associated with inflation too. And we might start to see a significant ramp-up in the prices of inputs into this whole infrastructure buildout. So you can point in a number of directions as to what some catalysts might be to take some of the froth out of the story," said Sonders.

Schwab started the year optimistic about the bull market broadening, but going to war with Iran narrowed the market, she noted. Schwab's midyear report notes the bullish case for U.S. stocks now rests on forecast-defying earnings, with Wall Street analysts projecting 25% earnings growth for the S&P 500 this year compared with less than 16% at the start of the year.

Stock valuation, however, is "a terrible market timing tool. You can look at periods where valuations have been very stretched or very cheap, and it doesn't necessarily mean that the market is going to move down when the market's expensive or move up when the market is cheap. I often say that valuation is really an indicator of sentiment more than anything else," said Sonders.

Looking at forward price-to-earnings ratio and subsequent one-year returns for the S&P 500, there's no correlation, although looking at figures over 10 years, more expensive markets do tend to be followed by lower returns and vice versa, she said.

While some market watchers express concern over valuations this year, the good news is that price appreciation the past couple of years has lagged earnings appreciation, Sonders noted. "So valuations have actually improved marginally because the E has been growing faster than the P."

What About Advisors?

Sonders suggested advisors pay attention to investor sentiment, consider new rebalancing approaches and look beyond the S&P 500 for diversification.

Sentiment is "a little bit more cloudy this time because you've got so many different trading cohorts that are dominating market behavior. So the retail trader, although they've been less involved in this move up from the March lows, but you know, systematics and long-short hedge funds and the commodity trading advisors, they really have been kind of powering the market. And their positioning I think gives you a good sense of what's going on in the market in the short term."

Sonders cited positioning data from Goldman Sachs, Vanda Research and Citadel that should be available to advisors. "And without it representing a market timing tool, it does, I think, give advisors, even if they're not trading off of this — they're not going to talk to their clients about short-term moves — but I think it helps provide language and context to some of these really short-term moves that seemingly can happen on a dime on narrative changes."

It's also helpful for advisors to understand what's driving inflation and how it shapes expectations for Federal Reserve moves. "I think that's paramount for anybody managing money, and then just making sure that they're employing disciplined strategies in an environment where you can see things very quickly turn on a dime," she said.

"So as much as it's boring to talk about diversification, making sure that not only the advisors understand, that their clients understand, that we have to not rethink diversification, but we have to understand that an index like the S&P 500, it's not quite the diversification play that it used to be, given that just tech and comm services combined is almost 50% of the index" market cap, Sonders added.

"There needs to be one step further analysis and discussion about diversification, especially for index-oriented investors," she said.

While many advisors and clients rebalance portfolios based on the calendar, this may be a time for volatility- or portfolio-based rebalancing, she said. That allows clients to capture some parabolic moves on the upside and take some profits. That strategy applies long-term investing disciplines "in a slightly different way with different context to match the current somewhat unique market environment."