While there are market pundits signaling that an economic turnaround may be just around the corner, Liz Ann Sonders, managing director and chief investment strategist at Charles Schwab & Co., isn’t one of them.
“I think we’re close to the end of the hiking cycle,” Sonders told advisors during the firm’s “Market Talk” webcast yesterday. While Sonders and other Schwab analysts expect the Federal Reserve Bank to hike rates at 25 basis points at their next meeting March 22, with possibly another 25-basis-point increase in May, they aren’t forecasting additional monetary tightening.
The recent bank failures, the fact that the U.S. is already seeing pockets of recession and tightening lending standards signify that inflation and the need to raise rates are being replaced by recession, Sonders said.
Additional indicators include soft measures like CEO and consumer confidence, and harder measures across the spectrum of housing and the factory sector, which have been offset by strength in services and the labor market up until now.
Now, Silicon Valley Bank’s implosion "points the needle more firmly toward recession in a traditional sense. We’ve been talking quite a bit about the notion of a rolling recession for a year,” she said.
What's changed, she said, is that the failures in the banking system and at SVB "certainly further dent the confidence channels which is always a feeder into economic activity. I think it also shifts what has been more an asset crunch into a more traditional credit crunch.”
But even before SVB, Sonders said there was a significant tightening of lending standards both on the commercial and consumer side of things that was “suggestive of recessionary type conditions," she added.
The chief investment strategist said she believes the biggest risk is the possibility of “contagion” from the SVP implosion and other regional bank failures, which she fears would negatively impact banking, credit and investor confidence, even if it doesn't impact S&P earnings.
But Sonders also warned that the comments she’s seen indicating the beginning of an economic turnaround based on the inverted yield curve beginning to right itself are a false flag.
An inverted yield curve--defined by the drop of yields on longer-term debt below those on short-term debt of the same credit quality— often portends the beginning of a recession. The yield curve on short- and long-term Treasury bonds first inverted last April.
“We’ve seen a bit of a steepening of the yield curve and seen and read comments that said the economy is out of the woods. Actually, that is not suggested by history. Inverted yield curves do represent a signal of recession, but often by the time the recession is ultimately declared as having started, you had already seen a steepening of the yield curve back into positive territory,” Sonders said.
Kathy Jones, the managing director and chief fixed income strategist at Charles Schwab & Co., said she also thinks “we’re near the end of the Fed’s rate hike cycle.”
This has been the most rapid rate hike in history, Jones noted.
The Fed has raised interest rates eight times in the past year, bringing the benchmark borrowing rate to between 4.5% and 4.75%. Most recently, the Fed raised rates a quarter of a percentage point, following a 0.5% increase in December. Earlier in 2022, however, the Fed raised interest rates by 0.75% at four consecutive meetings.
The next rate hike is scheduled to be announced March 22 when the Federal Open Market Committee meets.
For Jones, the biggest risk “is that the Fed has overdone it or will overdo it and we’ll get a pretty significant recession.”
She said she also worries that there are “a lot of people sitting on a lot of cash waiting to jump into riskier assets instead of taking advantage of the income available on safer assets right now.”
Jones said she’s concerned “we can get a huge amount of volatility as people shift around those portfolios. Because it’s not going to be 100% clear in six months or even 12 months what the long run implications of all of this are.”
Jeff Kleintop, Schwab’s chief global investment strategist, told advisors that his greatest fear “is how stubborn” inflation is.
“We’ve seen inflation come in waves in the past. It doesn’t just peak out and then come back down in a linear path. You can look back at the 1990-91 period where inflation peaked out and then on its way down, we saw periods where it picked back up again and stocks fell sharply because it suggested that policy needed to get even tighter,” Kleintop said.
That means “we may see waves of inflation and continued volatility in the market. In the last eight of nine months, we’ve seen stocks move 5% or more every single month, sometimes on the upside, sometimes on the downside. So, we may not be past that yet and it’s going to be an uncomfortable environment,” he added.
While Kleintop said investors could still take advantage of the bull market in international stocks that started a year ago, Sonders urged investors buying U.S. equities to seek out “quality and profitability.”