The average U.S. stock is down about 30% but investors have yet to capitulate to the current bear market, Schwab’s chief investment strategist Liz Ann Sonders told attendees this morning at Financial Advisor’s annual Invest In Women conference in Atlanta. Sonders actually used a more descriptive synonym for capitulate, a four-letter word that begins with “p” and ends with “e” to describe what is often viewed as the final phase of a bear market.
By her reckoning, bear markets come in a wide variety of styles and flavors. Even though  the current climate is characterized by a number of unusual factors including inflation reaching a 41-year high, a once-in-a-century pandemic and a war in Europe, Sonders cited a number of common characteristics to other Fed interest-rate hiking cycles with today’s market conditions.
These include a combination of growth and inflation overheating while the Fed attempts to tighten monetary policy to cool economic activity off. What markets may be about to see in July is a shift in phases to a lower trajectory for corporate earnings and profit margins.
Sonders told attendees that there is “even more pain [in the markets] under the surface of the indexes.” The upshot is that “we haven’t gotten to the point” of capitulation.
“I don’t expect volatility” to diminish,” she said. Instead, she told advisors to be on the lookout for “a full market washout,” even though it may never materialize. Were another drawdown to occur, then it might be an opportunity to buy, she noted.
Asked to compare the current bout of inflation to either the 1970s or the 1940s, Sonders said the price behavior in the post-World War II era is somewhat more accurate. That’s because “a lot of the drivers are somewhat similar to what we experienced post-lockdown.”
The wave of stimulus that “put a tremendous amount of money in the hands of individuals and businesses” was instrumental in fueling the current round of inflation. Initially, most of the federal dollars went to the “good side of the economy” partly because people had “no access” to spend money on frivolous activities.
The 1970s had a “lot of dissimilar drivers,” in her view. Chief among them were the deteriorating labor-market conditions, a problem that is not present today.
It's the supply-chain shocks of the 1940s in the winddown from a wartime economy that bear the most glaring similarity. But that era was also different. Sonders observed that demographics after World War II were younger and the unionization movement then  encompassed more than an Amazon wrehouse and a few Apple and Starbucks outlets.
Still, a recession this year is a higher probably than a soft landing, by her estimates. In any Fed tightening cycle, “the needle always points more towards a recession than a soft landing.”
This time there are a confluence of factors that compound conditions. The central bank is not only tightening; it’s also trying to shrink a $9 trillion balance sheet. “It’s possible we are already in a recession,” Sonders said.
Optimists point to the buoyant labor market as a possible signal that the economy can sidestep a recession. However, Sonders noted that unemployment claims already are ticking up and added that the jobless rate is a lagging indicator.
She urged advisors to focus on signals like hiring freezes, reductions in job openings and layoffs as “initial feeders” to a recession. A real key could be a letup both supply chains and the labor market. Conceivably, that could prompt the Fed “to take their foot off the brake,” she said, as it would free up bottlenecks in the economy.
Sonders suspects, however, this could be wishful thinking. “If we are in a recession,  the labor market will deteriorate,” she predicted. 
Moreover, there has never been “this big a drawdown in the equity market without a recession,” she declared.
In the 21 months from late March 2020 through late 2021, the Standard & Poor’s 500 and other stock market indexes doubled. Historical incidents of equity price appreciation at this rate are few. 
Asked if this represents a bubble, Sonders responded that many sectors of the stock market and other investment vehicles exhibited “micro bubbles.” She pointed to crypto currencies, “SPACs, heavily shorted stocks and meme stocks” as clearcut examples of this phenemoenon.
As market strategist for the nation’s largest discount broker, Sonders has been an avid student of investor sentiment. The outlook for equities, when measured by the University of Michigan consumer survey, is at an all-time low.
Sonders warned advisors that sentiment was hardly “a perfect timing indicator.” However, it could “lay the groundwork” for a counter-cyclical move.