Liz Ann Sonders is senior vice president and chief investment strategist at Charles Schwab & Co. Prior to joining Schwab in 2002 she was a managing director at U.S. Trust.
Harlan Levy: How's the jobs market in light of the latest strong numbers?
Liz Ann Sonders: It's getting better. I don't know that we want to extrapolate last month's strong numbers into subsequent months, because they are seasonal, typically, at the beginning of the year that can boost the first couple of months' worth of job numbers.
That said, the last four months have averaged over 200,000 new jobs per month, so we're certainly seeing some traction. The key this year will be that a big percentage of the jobs created will be from housing-related industries and activities. So housing will be a big driver of jobs and, related to that, economic growth as well.
H.L.: In light of February's Consumer Price Index rise - up 0.7 percent, a bit over expectations - is inflation a worry?
L.S.: I don't think it's a big issue right now. I suppose the monthly numbers will undergo greater scrutiny, because the Federal Reserve now has a more definitive threshold for inflation. But nothing yet suggests that we're getting to a scare point for investors. The overall CPI was a little bit above the consensus, but the core was in line with consensus. You do need to exclude food and energy, because they're the volatile components, and you have to be mindful of what the Fed is looking at. So the core index was up only two-tenths and was in line with consensus, and I don't think anything on the inflation front, either CPI, or PPI, of PCE, or inflation expectations suggest trouble yet.
We're strongly of the view that the conditions are not in place for an outbreak of inflation. We have a wide output gap. We have no velocity of money. We have no upward pressure on wages, and all of those are conditions that should keep inflation very much in check, at least in the near term.
H.L.: How's manufacturing?
L.S.: The Empire State Manufacturing survey was decent, although a little bit light of expectations. The manufacturing output data has been fairly volatile over the last few months. You had a surge in December. You had a decline in January. That said, generally manufacturing is improving. The Institute for Supply Management data has been up significantly since the lows of late last year.
As a result of some of this better manufacturing data and also because of stronger retail sales and the bigger drop in unemployment claims than what was expected, you are seeing economists in the last week or so ratcheting up estimates for the first-quarter Gross Domestic Product in some cases as high as 3 percent.
H.L.: What do you think GDP growth will be this year and next year?
L.S.: Generally, we're still in a relatively slow-growth mode, with 2 to 3 percent probably the most you can hope for in the next year or two. That's just a function of where we are in the debt deleveraging cycle, the fact that we're still in this era of financial repression. We don't think there's a high likelihood of seeing GDP jump to anything above trend growth for an extended time.
However, that's not a bad environment for the stock market, because it keeps inflation low and keeps the Fed's liquidity flowing. To some degree we used to call this environment "Goldilocks," but I don't think anybody would attach that label to today's economic environment, but slowish growth, keeping inflation in check, and the Fed on the side of the bulls is usually a pretty good recipe for the stock market.
H.L.: So what do you think stocks are going to do?
L.S.: I think they'll continue to do well. With sentiment where it is now, optimism has become a bit elevated in light of the rally and new highs, but any pullback, which could happen at any time for any reason, is unlikely to be terribly sinister. The problem for a lot of investors, particularly those who are on the sidelines, is that they're waiting for this elusive pullback and now are being forced back into the market.
But I think the market is reasonably valued. You can find any valuation metric to support your view. You can be a raving bear and look at the Shiller CAPE Index [cyclically adjusted price/earnings ratio] and support your bearish view by saying stocks are overvalued. You can be a raving bull and look at a forward price-to-earnings ratio, which is still about a multiple point or two multiple points below the long-term norm and support your optimistic views.
To some degree valuation is in the eye of the beholder and a function of what earnings stream you're looking at. I think looking at a variety of measures of valuation - forward P/E, five-year normalized P/E, the equity risk premium, the percentages of S&P 500 stocks that have dividend yields higher than the 10-year Treasury yield, price-to-cash-flow, I think collectively the market is relatively cheap, no worse than in line.
H.L.: How do you see the U.S. economy?
L.S.: What's nice and surprising in the near term is that the first quarter looks to be quite a bit better than what a lot of people thought. In other words, the expected hit from the tax hikes and now the sequestration was not as severe as people thought. And you're seeing that in consumption trends that have been quite a bit stronger than a lot of people thought would be the case, and retail sales were very strong. There was a greater expectation that the uncertainty initially about sequestration and then the sequestration itself and the uncertainty about taxes and then the actual tax hike, particularly the payroll tax hike which hit everybody, unlike the change in the Bush taxes, which only hit the wealthy, would be a bigger drag on growth. It turns out that it was not.
The primary reason that there was not a bigger hit is that we've got the wealth effect kicking in. Household net worth is probably into record-high territory this quarter. We only have the official data through the fourth quarter, but we're far enough along into the first quarter that we can start to extrapolate what net worth is likely to be, and it probably hit an all-time high this quarter, because the two biggest components of net worth are stocks and homes, which, obviously have been building higher.
So you have a wealth effect, and in the latter part of the quarter you had declining gasoline prices and declining energy prices overall, so that helped and was a bit of an offset to the rise in payroll taxes. That was a bit of a surprise for many economists and why they're now upping estimates, because things didn't fall apart as quickly as a lot of people thought in the face of rising taxes and government spending cuts.
H.L.: How is housing?
L.S.: Housing looks great. It's absolutely healthy. I've seen estimates as high as 800,000 jobs will be created from housing and housing-related activities this year and probably 1 percentage point of GDP growth will come from housing-related activity. In an environment where you're growing GDP at only 2 percent and change, that's a pretty big chunk of that.
H.L.: What do you think is the effect on the economy of the gridlocked Congress with the dueling budget proposals and a lack of compromise?
L.S.: There seems to be at least a step or a step and a half toward the middle on both sides. There are some concessions at least being discussed, and you've got some on the left conceding that, yes, something needs to be done in terms of entitlement reform. Certainly the left is going to propose something much more minor than what you're going to get from the right. The right is now taking a step in and saying that we don't want tax rates to go up, but we certainly might be able to give a little bit on carried interest or maybe some other deductions. So there is at least a baby step being taken by both sides. It's not far enough that we believe that some sort of "Grand Bargain" is likely, but maybe a little bit more of a compromise on the budget than was thought possible a few weeks ago.
But both sides have to come in. For the left to be fighting aggressively and not doing anything to cut Medicare or Medicaid, they don't understand the math. For the right to be saying we're not going to give anything on revenues doesn't understand the problems in the tax code relating to tax expenditures. You cannot solve this problem purely on the tax side. You cannot solve this problem purely on the spending side. You don't even come close. You absolutely have to have fundamental entitlement reform, and anyone who says otherwise hasn't done the math.
I think a lot can be done. And let's add Social Security in here, too. Doing the right things would not have as dire an impact in the near term as a lot of people think. The simple fact is that you have to start somewhere, and if you continue to push this into the future the problem becomes even bigger and harder to solve down the road.
But these are political hot potatoes in a very dysfunctional place called Washington D.C. right now. You could get several smart non-politicians into a room and solve Social Security on the back of a napkin in about five minutes. Medicare and Medicaid are a little bit harder. These are problems that can be solved, but you're dealing with politics.
In the meantime, we've seen a pretty significant improvement in the budget deficit. Outlays have been going down. Receipts have been coming up. The budget deficit as a percentage of GDP has gotten substantially better, but we're nowhere near a surplus by any means. The longer term problem, of course, is that even though the budget deficit is improving and we've slowed the rate of growth in debt, the rate of growth in debt is still growing.
H.L.: Is Washington affecting the stock market as much after years of this standoff?
L.S.: I think the market is paying a little bit less attention to Washington's antics right now. I'm not sure if that's a good or a bad thing. It's just what it is. That's why we have not seen the kind of volatility that we saw in the August 2011 debt ceiling debacle. The market is saying, "You know what? Washington is a mess. We don't know if it's going to get fixed, but at least we have the Fed on our side," and businesses that are bucking the uncertainty regarding Washington are saying, "We've got to get back to the business of business."