Today I posted to my YouTube Channel (HERE) an interview with Liz Ann Sonders, Equity Strategist at Schwab recorded on December 15, 2022 with my friends John Fagan and Brendan Walsh of Markets Policy Partners. We discussed the Fed, the economy, and the markets and you’ll see that she said the US had been in a rolling recession, and that we were (then) progressing into what she expected would be an extended period of normalized interest rates, market-based price discovery, and market-based capital allocation.
She was spot-on about rates stabilizing at a level that historically has been viewed as an appropriate “cost of funds” in the 5% range for short term government bonds. This causes investors to be more risk averse than it is in a Zero Interest Rate environment that had characterized much of the last decade.
Many professional investors were warning at the time that the rapid increase in short rates set by the US Federal Reserve was likely to force a recession, or at least cause a financial accident (like SVB)- but Liz Ann was forecasting that this move would restore a healthy investment environment. Good call because the stock market’s strength would indicate exactly that!
Liz Ann Sonders has been with Schwab for almost 23 years, and during that time she has been the stalwart force and guiding light for customers of one of the most successful financial institutions of this era. Schwab has gained the trust and confidence of one of the largest bases of retail investors in the business with 34mm and has Liz Ann has been the only voice covering the US market.
We had an engaging discussion that covered a broad range of topics in great detail. Here are the points we covered, and the Timeline of the interview is laid out below:
1) The Zero-Interest Rate Policy (ZIRP) environment led to malinvestment from a lack of price discovery and this stifled growth and was a contributing factor to the weakest economic recovery ever, although it was the largest.
2) Fed tightening impact on markets- better environment for the private economy to invest productively. Has already hit many sectors that have been in recession like housing, and Fed tightening’s next big hit will be to employment… just like Roadrunner having just gone beyond the cliff.
3) The bond market is more likely to be predicting rates than the Fed.
4) The “great moderation” is over, that is the extended period of disinflation and we have entered a period of more normalized inflation.
5) During this period of disinflation, the normal inverse correlation between stocks and bonds reversed- we are likely to be entering a period where the correlation will reverse and normalize.
6) GDP growth will be more a function of advancement from technology than the interest rates or federal debt levels. a. Expect more variability and shorter economic cycles, but growth rates could be higher or lower.
7) China- growth depends on how the people of China react to opening and a potential rise in infections and deaths.
8) Factors are the best approach vs value/growth or large cap/small cap.
Timeline:
00:00 Liz Ann Sonders Intro- Question: Can the US economy grow if Fed Funds rate stabilizes around 5%?
01:40 The US economy was stifled by the malinvestment of ZIRP- zero interest rate policy
02:58 Where do you think the Fed will stop and hold the Fed Funds Rate? Bond markets are reflecting what is likely to happen. We are seeing plenty of economic weakness, and we are actually in a rolling recession already where pockets of the economy are in decline.
04:05 Market leadership is a key change caused by higher rates. Equal-weight indexes are outperforming market-weight indexes for the 1st time in a long time.
07:27 Fed balance sheet reduction hurts markets, but not necessarily more than rate hikes
08:06 The San Francisco Fed "Proxy Rate"- incorporates FF rate, balance sheet, and guidance.
08:35 Using the balance sheet is an effective tool for financial system instability.
09:50 The Fed Put - financial market volatility vs financial system instability
11:37 The Fed does not want the stock market to go up.
15:39 Federal Debt- politicians are addicted to over-spending for now, as rates rise, this should change
17:35 Compression of economic activity - disinflation today in housing, sub-sectors of retail from inventory problems, and labor market is next real impact.
20:53 Compression is expressed in energy very clearly, and volatility is the problem- global growth is an issue
21:53 China re-opening is dependent on how people react, not just a decision by Xi.
26:21 How would you define a Fed "pivot"? History of Fed hiking cycles
32:55 Fun with Paul Volker!
34:00 Disinflation era is over- Bonds v stocks inverse relationship must be restored.
38:01 Next phase of economic growth. Shorter cycles and driven more by capex and tech innovation like nuclear fusion.
43:50 Congress, policy, regulation impact on economic growth- rise of moderates may help
47:50 Monetary supply - M2 impact on the economy and markets.
50:00 Liquidity and markets, FTX exposed
51:00 Private equity markets and public equity markets- also likely to reverse
52:40 Micro-bubbles and creative destruction
55:30 New environment should improve competitive advantage for incumbents with cash flows
56:50 R2000 vs S&P600, very different benchmarks. Factor-based investing is best.
58:55 Household equity allocation vs Institutional allocation