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LIZ ANN SONDERS, SENIOR VICE PRESIDENT/CHIEF INVESTMENT STRATEGIST, CHARLES SCHWAB AND CO. INC, IS INTERVIEWED ON BLOOMBERG SURVEILLANCE
OCTOBER 20, 2011
SPEAKERS: KEN PREWITT, BLOOMBERG SURVEILLANCE HOST
CAROL MASSAR, BLOOMBERG NEWS
LIZ ANN SONDERS, SENIOR VICE PRESIDENT/CHIEF INVESTMENT STRATEGIST, CHARLES SCHWAB AND CO. INC
8:02
KEN PREWITT, BLOOMBERG SURVEILLANCE HOST: We're going to get another look at earnings and other things having to do with equities with Liz Ann Sonders from Charles Schwab and Company. Liz Ann, good morning.
LIZ ANN SONDERS, SENIOR VICE PRESIDENT/CHIEF INVESTMENT STRATEGIST, CHARLES SCHWAB AND CO. INC.: Good morning, everybody.
PREWITT: What is your take on earnings season so far?
SONDERS: I think Mike is right. So far, we have had a pretty decent season. It looks like we will beat expectations by a couple of percent. The forward guidance has not been disastrous and it may reflect just that analysts got quite skittish, particularly back to August, and probably more than sufficiently lowered expectations. So we've got the bar a bit lower and therefore the ability to hurdle that becomes greater.
CAROL MASSAR, BLOOMBERG NEWS: Liz, you know earlier this month, you wrote recession fears have mounted, but the picture is still mixed and it is not yet conclusive. Do you feel like we have any more clarity almost a month later here?
SONDERS: Yes, I think we have more clarity that suggests recession will be avoided. We have gotten both ISM ratings on the services and manufacturing side, both bounced up. Even some of the regional surveys, although the headlines may not have looked great on the surface, if you look down into the details they were much better. Chain store sales, retail sales, construction spending, even some of the housing starts and permit numbers were not bad. So the list goes on and on.
And the funny thing is is I have been against the recession case for the last couple of months now. And some of the push back I have gotten is what are you seeing that nobody else is, how can you think we have a strong economy if the only two options for the economy are recession or strong growth? I don't think we are going to have strong growth, but a kind of muddle through environment is distinctly different than a recession. And that is what I think we are going to get.
PREWITT: Well, when you say muddle through, what is that - two percent GDP?
SONDERS: I actually think we could get close to three percent for the third quarter. I think we have had some coiled spring effects that came from the incredible weakness, much of which was cyclically driven in the first half of the year, not the least was the spike in energy prices.
So every $10 increase in oil prices shaves about a half a percentage point off of GDP. So if you do the math, you could get a percent and a half of GDP growth purely from the spike we saw in energy prices. So you've got the commodity price cycle moving in the opposite direction.
The other interesting thing is that when we saw those downward revisions to prior GDP, those were downward revisions to real GDP. Nominal GDP was actually revised up. It was just the deflator that was higher than originally thought.
Now, I think we have the opposite affect, where we are starting to see a falling deflator because of falling inflation, which means even if nominal GDP is not very strong, we are going to be subtracting a lower deflator, which means we might get a little bit of a boost to real GDP. So I think third quarter might be okay.
HOLLAND: For the listeners, Liz Ann, the record is that you are not exactly a Pollyanna. You've given some very optimistic comments, yet in 2008, you were among the few people who identified the source of some very significant problems and actually prophesied the meltdown. You also then called the turn. Where are we today with equity prices relative to your relatively optimistic view?
SONDERS: Well, thank you for your very generous and kind comment.
HOLLAND: You did (inaudible).
SONDERS: So I think that at an 11 multiple on forward earnings, the market is I think obviously cheap. The concern though is what the path is for the denominator E. So given that 2012 estimates are still in question, and I do think that if I am wrong about avoiding a recession and we do go into one, you could suggest that estimates have not been cut sufficiently. So maybe we are in a little bit of a holding pattern.
That said, I think relative to a 16.9 long term median for forward earnings and the 11 where we are right now, you have built in a pretty healthy cushion. And I think the 12 percent nine day rally we saw may reflect something that I think is being under appreciated, which is, yes, there are still negative tail risks, most of which probably have a European flavor to them.
But I think that there are also positive tail risks because the expectations bar has been set so low, you get even the slightest bit of better news, whether it is on the domestic economy or maybe in a month or so what comes out of the super-committee or Europe, you can have as fast a rally as you've had some of these sell offs. And I think we were reminded of that with the big rally that we saw into last week.
HOLLAND: Could you give us any insight into what the Schwab clients are doing as a group now?
SONDERS: You know, it is interesting, one of the ways that we see activity is by looking at the difference between what our Schwab clients who kind of do it themselves, do-it-yourself investors, or individually driven versus those who have some sort of advised relationship.
And interestingly, those that have had an advised relationship, where let's assume there is a little bit more discipline around the management of the money, there is more strategic asset allocation, that has been a cohort that has expressed much less skittishness. They have not kind of panicked out or panicked back in. And I think that it goes to the notion of that discipline, of rebalancing and diversification. All the things that are so boring to talk about on shows like this.
But if you really heed them and adopt them as part of your philosophy, you end up being able to kind of weather the emotional storm of what we have experienced in the last several months more than if you are - for lack of a better way to describe it - winging it.
PREWITT: What sort of shape are consumers in, and what is the bearing on the holiday season for retailers?
SONDERS: You know, consumers are in much better shape than they were three years ago. They are certainly not back to full health.
But the financial obligations ratio as one proxy for that is at about an 18 year low right now. If you look at debt service ratio, consider there being three zones of debt service - very high debt service, which is where we got to back in 2008; sort of a neutral zone; and then low debt service zone in which normally the economy does quite well. We are actually about to breach below into the low debt service zone because of just of how herculean the efforts have been on the part of the private sector to pay down debt and boost savings rates, which has been going on for three years now.
Of course, the problem is we are now launching that for the public sector very necessary. But the private sector has been doing it for about three years right now. And I created an index several years ago that I called the consumer stress index. It is a take on the misery index, but it has many other components to it besides just the inflation rate and the unemployment rate. And that has actually moved down into positive territory, marginally positive territory, meaning down, meaning less stress.
So I think what we are seeing, and I think it is show when you look at the difference between consumer sentiment or confidence readings and consumer spending numbers, we have never seen a gap this wide. So we are experiencing right now the what people say and what people do are different things. That doesn't mean the consumer is going to boom by any means, but consumer spending can probably track nominal income growth, which is a positive number. It is not a boom, but it is a positive number and should help keep GDP afloat.
MASSAR: Liz Ann, how comfortable are your investors - Schwab investors - with the volatility that is out there? I am looking at images of Greece and elsewhere around the world. I mean how comfortable are your investors with this? Are they kind of getting used to it coming off of the crisis?
SONDERS: I think some probably are, but it is still a measure of angst that isn't going away anytime soon. I wrote a report this past Monday on high frequency trading and impact on volatility and correlations, and part of the reason why I wrote it - not that I necessarily have any greater insight into the impact of high frequency trading on the markets, but I was getting the question more and more.
I think people are very concerned about what they view to be a less level playing field, looking particularly recently at not just the intraday swings, but the dramatic reversals that we have seen in the last hour, which may be a function of some of what I wrote about with the use of leverage to exchange traded funds and the rebalancing that those have to go through throughout the day.
So it is something I think, not just for our investors, but for individual investors in general, that has really plagued their psyche is this kind of rampant volatility that really says to a lot of them I am not even going to try to play the game, I am just going to get my percent in treasuries and not worry about it.
PREWITT: Liz Ann Sonders, senior manager of research in competitive analysis at Charles Schwab. More with Liz Ann coming up here in a few minutes.
8:10
(BREAK)
8:19
PREWITT: On the phone, we have Liz Ann Sonders, the chief investment strategist at Charles Schwab. We were talking about retailers and Michael added the higher end - the Tiffany's and Ralph Laurens - are going to be doing better than the Wal-Marts and Dollar Generals. Is that pretty much your take as well?
SONDERS: Yes, I think if you look in relative terms, there is no question that the upper end of the income spectrum people are a little bit more flush. But chain store sales tend to capture some of the lower end, too, and those are doing pretty decent, too. So this is not solely just a high end versus low end. We are looking at I think better than expected upside across the spectrum.
MASSAR: Liz Ann, does that mean then you will be buying some of the retail names, those higher end retail names?
SONDERS: Well, some of the discretionary - the broad, I mean I am not the stock person at Schwab, but the - at the sector level, consumer discretionary, which includes almost all of those with the exception of some of the discount retailers that will be in consumer staples, we actually have a neutral rating on consumer discretionary and actually an under perform on consumer staples.
So our outperform ratings are technology and industrials, clearly have a cyclical bias to them, where our under performs have a defensive bias. And we tend to make our sector recommendations with a slightly shorter term perspective and it does reflect what we already talked about in the last segment, which is our view that although the economy is not booming, a recession will be avoided and I think the market is going to maybe punish - at least in a relative sense - defense in favor of more cyclically oriented earnings.
HOLLAND: Liz Ann, with that comment, we just had Marty Fridson in a few minutes ago talking about junk bonds. He was referring to the potential for eight to ten percent kinds of returns from junk bonds over the next several years after default. Do you think common stock will be competitive with that or exceed that?
SONDERS: Look, given a 12 percent rally in a nine trading day, I would tell you that there are going to be probably segments in the market, segments of time in the market where you probably do quite a bit better than that. I think to try to estimate what longer term returns are going to be, your guess is as good as mine.
But my bias say for those negative tail risks maybe coming out of Europe that I talked about, that I think could wreak havoc with the markets in the short term, I think fundamentals of valuation, certainly sentiment do support a market that will fair pretty well. And our bias has been within, from a tactical perspective, yes, U.S. equities over junk bonds.
HOLLAND: Interesting.
PREWITT: And U.S. equities over emerging market or European or anywhere else?
SONDERS: Yes, if we were to rank the three broad categories with Europe being one of them, it would be U.S., emerging markets, and then non- U.S. developed markets.
PREWITT: Why don't you like emerging markets?
SONDERS: We do. We just like -
PREWITT: Like U.S. better.
SONDERS: We think the U.S. will continue to outperform, which they have been. We think we are not quite through the concerns about some of the bigger emerging markets, notably China.
That said, emerging markets have become much more reasonably valued in light of their under performance. And we actually think many emerging markets, including China, may be on the cusp of being able to start to loosen monetary policy, which we think will actually feed back into a better loop broadly for the economy.
I think that has been one of the hits to the global economy is the developed world has been loosing policy, which has contributed to rising commodity inflation, which hit the emerging markets, which caused them to have to tighten, which fed back into negative growth, and so on and so on. But we may be able to break that negative cycle with this inflation coming down, which may allow some of these emerging economies to begin to ease. And that certainly would be a more favorable environment for their equity markets. We are just not quite there yet.
HOLLAND: With that as a backdrop, Liz Ann, you have recently written about diversification. For the listeners who look at things right now and see things - they seem to be moving all in the same direction at the same time in the same volume and dimension, what can you tell people? What can you advise them about diversification today as it relates to their anxiety and angst?
SONDERS: Look, it's true. When you go into a period where markets become very, very highly correlated, which they clearly have, hence the term risk on, risk off for describing the environment, then most of the risk assets have seen correlations increase. And it gives you the sense that diversification no longer works, and maybe the simple math tells you that that is the case.
That said, I don't think that that is a long lived phenomenon. I think it is a crisis driven phenomenon that has caused these correlations to go up. So the assumption is they will go back down again and traditional diversification will work.
But the thing that does happen when you get into a very highly correlated environment is you can find - you can expose mispricings because if every single asset class of maybe the risky variety is moving in tandem, we know for certain that the fundamentals of those assets classes are also not moving in tandem.
So it gives you an opportunity to look inside, do your homework, and figure out where the mispricings are, what maybe has moved up that doesn't have the same justification from a fundamental perspective, or down and actually has much better fundamentals. So it gives you an opportunity to maybe be a little bit more tactical, look for those opportunities to establish positions in the portfolio even in a high correlated world when things, correlations come down, you are now owning the right asset classes, the right securities, the right industries, etc. So that is one benefit that comes from it.
And then also volatility, rampant volatility gives you more opportunity to do what we know we are always supposed to do, which is periodic rebalancing, trimming back our outperforming securities, asset classes, industries, sectors, whatever it is. And we are now provided more opportunity to do that, and I think investors ought to take those opportunities.
PREWITT: Liz Ann Sonders, the chief investment strategist at Charles Schwab.
8:25
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