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 in both supply chain bottlenecks 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 signals that markets were in a bubble last year, 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 clear-cut examples of this phenomenon.
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 investor sentiment was hardly “a perfect timing indicator.” However, if investors remain increasingly negative, it ultimately could have a positive effect on stock prices. After all, consumers and the public at large have often despised stocks at the start of many extended bull markets.
At the same time, this isn’t 2009.
Sonders told attendees how she received one of the great buy signals of her life at a dinner party in March 2009. On the Friday night before March 9 of that year, she and her husband attended a party filled with gloomy Wall Streeters.
A 30-year investment banking veteran showed her some pity, saying, “Liz Ann, I don’t envy your position. I don’t think the market will ever come back to prior highs.” He expressed doubt that the retail investor would “ever come back,” adding that he didn’t know “how a firm like Schwab could possibly survive.”
As she and her husband got in their car, he looked at her and said, “Did you hear it?” They realized that the proverbial bell, the one that rarely rings at the bottom of bear markets, had just clanged.
The market dislocations experienced today bear little resemblance to that era, when stocks had fallen more than 50%, unemployment was 10%, and many home mortgage loans exceeded the value of the underlying properties. But Sonders believes there will be opportunities for investors.
The sprawling complex of index and factor funds inevitably creates imbalances and dislocations. “Utilities live in the value indexes, but they are more expensive than the S&P 500,” she said.
Even within technology, investors who looked for high-quality companies within the value sector last year have found some of this year’s leaders. “You can find opportunity within all 11 [S&P] sectors,” she said.
At the same time, she warned that advisors and investors can “fall into traps” by simply dividing the market into growth and value and “investing passively.” Changes in market leadership trigger a reclassification of companies in and out of different indexes, asset classes and style factors. Netflix and Meta Platforms, for example, are winding up in some value indexes.
The next cycle is unlikely to enjoy the same powerful tailwinds the last one did. From 2014 on, asset management complexes like JP Morgan, AQR and GMO steadily predicted U.S. equities would generate low single-digit real returns or worse for the next five or 10 years. Sonders wasn’t among them back then.
Most of those estimates were based on current valuations and past performance, which conventional wisdom maintained borrowed current returns from the future. Sonders told advisors the best indicator of future returns is actually the level of U.S. household equity ownership, data that the Fed tracks.
Now models using this data set predicts low single-digit returns, Sonders said, or about 3%. That’s something, but not much, to get bullish about.