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. She is a regular guest on CNBC as well as Bloomberg TV and radio and is often quoted in The Wall Street Journal, Barron’s, and The New York Times.
H.L.: What are the lessons from Greece’s debt crisis?
L.S: The important message about this to not only the European Union, but, broader, to any nation that has a high and rising debt problem — and the U.S. I would very much put in this list — is you get to a point where debt as a percentage of Gross Domestic Product makes it maybe not impossible to grow the economy, but there are then huge impediments to growth. Greece is the poster child for that. It’s a warning shot across the bow about the tough decisions that need to be made when you get debt to such an egregious level.
H.L.: What should the U.S. do about our debt situation?
L.S.: It has to be a three-pillared approach. We know we’re getting the tax increases. That’s set in stone. But there has to be a greater amount of attention on spending restraint, and I don’t think there’s been enough of that yet, and it’s tough, anyway, to tackle the entitlement side of that problem. And then we need to make sure that we are establishing the conditions necessary to grow the economy, because that is ultimately the only thing that gets you out of the kind of debt situation we’re in.
H.L.: Is our economy truly growing?
L.S.: I’ve been very optimistic about the economy over the last year, and now that we’ve turned GDP basically from minus-6 to plus-6 there’s some realization that we have some semblance of a recovery here. It’s more than just a “sugar high.” This is a legitimate recovery, in many ways as a result of a lot of the traditional forces that kick in in recoveries. You get inventory rebuilding, which pushes up industrial production, which pushes up the need to hire. We’ve got very strong exports. We’ve got businesses in very healthy shape right now in terms of their balance sheets. There’s really a decade’s worth of pent-up demand for business capital spending, because that was really absent throughout the last up cycle in the economy, because businesses came out of the ’01 recession so hurt that they went through their deleveraging process and kept capital spending very much in check. And we’ve even started to see a turn in consumption. Retail sales have been much stronger than expected. So a lot of what you tend to see happen as the economy moves from recession into recovery and then eventually from recovery into expansion is happening this time, too.
H.L.: What could hinder the recovery?
L.S.: There are still significant uncertainties that are probably elongating the period between the layoff environment that we had a year ago and the kind of robust hiring that you would like to see eventually kick in. From a regulatory reform perspective, if and when something gets passed then at least we know what’s there, and we start to lose some of the uncertainty associated with that. We also have uncertainty still as to whether the 2003 tax cuts will be extended. That’s got a time-certain element to it. And some of it is the natural forces of competition. There is a lot of hesitancy by small businesses to borrow, to invest, to hire, but when their competitors start to do it, animal spirits kick in. They’ve already kicked in in terms of large companies, but it hasn’t kicked in as much for smaller companies. It happens over time.
To some degree we’re in the sweet spot, with inventory rebuilding and the huge surge we’ve seen in industrial production, the unquestionable V-shaped recovery that we’re getting in manufacturing. We’re in, if not moving in, to what is called the self-sustaining mode of the recovery/expansion.
H.L.: Earnings are mostly in, most beating expectations. Was cost-cutting a major factor or top-line sales?
L.S.: Corporations are pretty healthy, and top-line growth in the last two quarters, this one included, is actually beating consensus estimates by a greater amount than bottom-line is beating consensus estimates. That tells you we are two quarters past the point where it was really all about cost-cutting and very little about top-line sales growth. Certainly the estimates out through the rest of 2010 reflect a very strong environment for top-line growth, not just bottom-line growth.
H.L.: Is a stock market rally still sustainable?
L.S.: I think it’s going to be a choppier year for stocks with an upward bias. We’ve got issues of the Federal Reserve’s exit strategy, even though I don’t think they’re going to raise the fed funds rate any time soon. Unquestionably, they’ve already started to pare back liquidity with the end of quantitative easing, with shutting down some of the liquidity facilities they put in place during the emergency. The move toward tighter monetary policy is already afoot. It’s not going to be in short-term rates anytime in the future, but that tends obviously to cause some volatility in the market.
We’ve also got what has been a tremendous surge in the leading indicators since last March, but we’re at the time in the cycle when you would start to expect to see a peak and a rolling over in the leading indicators. It shouldn’t send any economic alarm bells. It’s very natural for that to happen, but it does tend to bring in a little bit choppier an environment for stocks. Generally the path of least resistance is still up. The technicals of the market, momentum factors, and breadth look extraordinarily good. But in the shorter term, the sentiment environment, i.e., a lot of optimism as a result of the market rally, is a little bit more troubling. because the market tends to move contrary to consensus sentiment. We may need to work off some of this excess optimism so we can go back to the kind of environment, the so-called “climbing the wall of worry,” which is a healthier environment for stocks. It’s a mixed bag right now, and there’s a little froth in the market.
H.L.: What do you see ahead for jobs?
L.S.: The job situation is improving. It’s by no means good, but the decline in initial unemployment claims is actually tracking closer to what we saw coming out of the early 1980s’ back-to-back recessions, and that turned out to be an incredibly robust job creation period from 1983 on. I’m not suggesting that that’s what we’re going to get, but this notion that we are in another jobless recovery is not suggested by the leading indicators for jobs – initial unemployment claims down fairly sharply, the surge in hiring temporary workers, the surge in corporate profits, which is obviously a necessary condition for hiring.
H.L.: How is the housing market?
L.S.: We stopped the implosion but have been bouncing along the bottom for some time. Inventories have been coming down. Recently we had a little blip back up as more foreclosed homes come onto the market. It’s certainly not going to be a smooth ride. But some of the leading indicators, building permits and housing starts, are up quite sharply. So we’re still in the process of finding a bottom.
H.L.: Are there any sectors you like?
L.S.: We have an “outperform” rating on health care. It wasn’t because the reform passed. We looked at the fundamentals of momentum and risk and valuation and growth and found that there was a pretty compelling valuation demographic. We’re adding another outperform, but I can’t share that before we make the change on Friday.
Disclosure: No positions