Liz Ann Sonders, Charles Schwab & Co.’s senior vice president and chief investment strategist, warned as early as January that, amid unbridled market optimism, the economy would take a hit from coronavirus in the short term. Now she forecasts the recovery in a “Y” shape, with the U.S. economy currently plunging “straight down.”
In a May 13 interview with Treasury & Risk sister publication ThinkAdvisor, the Fordham University MBA, who served on George W. Bush’s President’s Advisory Panel on Federal Tax Reform, discussed what it will take for the economy to be fully open for business again, the corporate debt crisis, and cautions of pandemic “second-order effects”—in addition to “the new version” of the world post-pandemic. Here are highlights:
THINKADVISOR: What’s your forecast for the recovery?
LIZ ANN SONDERS: I see a capital Y-shaped recovery. Before the pandemic, there was a perception that the economy was in great shape, but manufacturing and business investment were already in recession. So an important portion of the economy was heading down. Now we’re in the stem of the Y—and going straight down. Once we rebound, we’ll [move up] the stem, but probably at a much slower pace of growth.
TA: What could trip things up?
LAS: If there’s an increase in the coronavirus as the states open and the economy is shut down again—though I don’t think that’s the expectation—there [could be] second-order economic effects: bankruptcies and defaults picking up. Companies could say to workers they laid off on a temporary basis, “You’re laid off permanently.” [In any case], there’s going to be as much of a solvency issue as a liquidity issue—bankruptcies will [increase].
TA: You started writing about and discussing coronavirus fairly early—the end of January—forecasting that it would bring a hit to the economy in the short term. So Covid-19 was on your radar screen even then, correct?
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LAS: Coronavirus was on my radar screen as a potential negative catalyst. But what was mostly on my radar was too much optimism—investors thinking that nothing could go wrong. That’s often an accident waiting to happen, but it typically needs some trigger. “This coronavirus could be just such a catalyst,” I said. I didn’t realize it was going to be the, sort of, mother of all negative catalysts.
TA: What do you make of the market decline yesterday and today? [The week would end with the S&P down 2.3 percent, the worst weekly drop since late March.]
LAS: Having retraced more than 60 percent of the market rally—up 32 percent in a month from the March lows—in a very short period of time, you could argue that the market was pricing in too rosy an outlook. I think we’re digesting some of that. The market looked a bit toppy both technically and sentiment-wise, and that’s a recipe for some consolidation.
TA: What characterized it as toppy?
LAS: You were starting to see a bit of frothiness in investor sentiment—a lot of speculative chasing of certain stocks that caused it to become even narrower than it had been—the top five stocks representing about 21 percent of the S&P as perceived winners. That’s where all the momentum had been.
TA: What’s your outlook for corporate earnings?
LAS: Every single day, we’re continuing to see analysts ratcheting down their earnings estimates—and almost every day they drop about a dollar. We [collectively] don’t get much color [information] from companies because so many of them have withdrawn guidance, which means you can’t do any kind of accurate evaluation.
TA: Do you have any sense, though, of what earnings will be?
LAS: If you add up all the number-crunching on individual companies that analysts are doing, it’s $127 [per share] for 2020 S&P earnings. But the top-down estimates from strategists and economists have been as low as $70. That’s Goldman Sachs’ worst-case scenario. [In January 2020, the estimate was $177.77 for S&P companies, according to FactSet.]
TA: If analysts don’t have clarity, how are they coming up with any numbers at all?
LAS: They’re kind of flying blind; they’re guessing. They’re probably using their erasers more than their pencils. They just keep ratcheting the number down, down, down.
TA: Are there any sectors that you like?
LAS: Among the 11 sectors, we have only one outperformer: healthcare. It was an outperformer pre-dating the pandemic, so it wasn’t something we changed. But it’s our one outperformer now.
TA: The states are now opening up, and that does pose the risk of triggering a second wave of coronavirus. Any further thoughts about this?
LAS: We have to be careful, but we can’t keep economies shut down in perpetuity. Poverty kills more people than just about anything else, including a virus, Stanley Druckenmiller [manager, Duquesne Family Office] said yesterday in a webinar.
TA: How, then, will the economy “get back to business”?
LAS: There’ll have to be a weighing of information; more testing; and, hopefully, therapeutics and vaccines. It’s legitimate to think about tradeoffs. There’ll be the ability to be a little more finetuned with how we go about this. Two months ago, the only answer was shutting down everything until we learned more. Now, every day that goes by we learn more.
TA: How urgent is the need for another stimulus bill? The House just passed the Heroes Act relief package, but the Senate is expected to reject it.
LAS: The Fed has done a number of things, including creating a suite of new programs and facilities. On the lending side, these facilities, in many cases, are still there as backstops. They’re in the background, in the event that things get so bad companies are unable to access the liquidity they need through traditional channels. That many of these facilities haven’t been tapped is one of the few bright spots in this whole story. If we started to see a greater utilization of these, it would be a bigger problem.
TA: What are your thoughts about the ballooning federal deficit? It’s been big a concern of yours.
LAS: The number-one question I’ve been getting from clients at the virtual webcasts we’ve been having is on the theme of the deficit and debt, and what the Fed has been doing regarding inflation. They want to know: How do we get out of this debt hole that we’re going into even more deeply?
TA: What’s your answer?
LAS: The Fed’s [increasing the money supply—a.k.a., “printing money”] causes inflation only if the money that’s pumped into the financial system comes out via lending channels into the hands of borrowers who spend or invest it. But there’s no demand for borrowing. De-leveraging on the part of households will continue, and savings rates will probably go even higher coming out of this crisis [than after the 2008-2009 crisis]. But corporations are going to be the next cohort [so to speak] that has to seriously de-leverage because they’re the ones in the midst of a crisis right now.
TA: So you’re not concerned about inflation at the moment?
LAS: In the near to medium term, there’s more of a deflation problem. My answer to the clients that ask about inflation is: “We don’t have inflation to worry about right now, though there is a very strong relationship between the level of debt and the economy’s ability to grow at anything resembling a healthy pace.”
TA: Please elaborate.
LAS: We just exited the longest economic expansion in history, but it was also the weakest by far—I mean, by far. I think a big part of the reason was the high and ever-rising burden of government debt. I’ve been calling it a simmering crisis. Government debt has a huge impact on economic growth.
TA: What major changes do you expect to see in the economy post-pandemic?
LAS: Our economy has been close to 70 percent driven by consumer spending. In the new version of how our world is going to look, that will shift down. Hopefully, taking its place will be investment: private sector, capex [corporate capital expenditures], healthcare investment, infrastructure investment. But it will take a while for those to happen and there will be a heck of a lot of economic displacement as we go through that transition.
TA: What are the changes that consumers will feel more directly?
LAS: The genie is out of the bottle with regard to remote working—not that every company will have every employee working remotely, but this is a really powerful force for the future. And there are so many ripple effects that need to be considered.
TA: Such as?
LAS: [The impact to] corporate real estate in certain parts of the country. In New York City, for instance, will companies need to have as much office space [as they have historically]? Also, working remotely, people don’t need to live in expensive metropolitan areas: From a lifestyle perspective, they might be free to live wherever they wish.
TA: What other changes do you predict?
LAS: Probably less leisure travel that requires getting on an airplane or booking a cruise. So there’ll be more local entertainment. Another huge ripple effect: The sports industry has been so important, but how long will it take for people to be willing to crowd into a sports stadium, especially an indoor one?
TA: What are some of the big pluses that you see occurring in this new world?
LAS: We’re speeding up the process of what we do digitally. For instance, older people who had never heard of Google Meet or Zoom are now communicating with their friends that way. And telemedicine has become a huge trend. So there’s a greater adoption to living digitally—and that’s a game changer.
TA: Do you foresee the country’s supply chain shifting as a result of the pandemic?
LAS: Yes. That’s been an issue but has now been brought even further to the fore, particularly with regard to health-related products, even those that aren’t impacted by the virus. For example, more than 90 percent of all antibiotics used in the U.S. medical system come from China. So supply [sourcing] will change, not necessarily everything coming back to domestic shores but at least closer to home and more diversified.
TA: Kathy Jones is Schwab’s chief of fixed income strategies, but would you briefly discuss what’s ahead for the bond market?
LAS: Recently [the group has been] putting more emphasis on TIPS for people who are concerned about inflation longer term. We think that though there’s very little risk of inflation in the near term, one of the longer term potential drivers of higher inflation is de-globalization.
LAS: In the last 30 years, globalization has been a big force bringing down and keeping down inflation. So you have to think that de-globalization might eventually put some [upward] pressure on inflation. If we want to take back control, whether it’s because of nationalism or protectionism or just the obvious need to diversify supply chains and bring things closer to local shares, that potentially could bring some inflation in the longer term.