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Liz Ann Sonders, Managing Director, Chief Investment Strategist, Charles Schwab & Co.

Portfolio > Economy & Markets

Schwab's Sonders Is Waiting to See What Might 'Break' in Economy

By Dinah Wisenberg Brin

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What You Need to Know

  • Sonders cited a deterioration in confidence among small businesses.
  • Concerns are driving demand for quality and liquidity, she said.
  • Sonders pointed to ongoing lagged hits to the economy.

Stocks could end the year strong but many risks remain, according to Liz Ann Sonders, Charles Schwab chief investment strategist. She cited concerns that quickly rising long-term bond yields could cause something in the economy to “break.”

Another better-than-expected earnings season or investors buying on dips could trigger a strong year-end stock performance, she said Tuesday in response to a listener question on the Hedgeye Investing Summit webcast. 

“I’m never surprised by any move on the part of the market. But there are still a lot of risks out there,” said Sonders, who advocates long-term investing rather than trying to time the stock market.  

“Neither get in nor get out is an investing strategy,” she said. “That’s just gambling on two moments in time. … Investing should be a disciplined process over time.”

‘Befuddled’ by Possible Rates Pivot

Sonders made various predictions about the economy, including casting doubt on the idea that the Federal Reserve will pivot to cutting interest rates under current economic conditions — with a tight labor market and inflation above the central bank’s target despite some choppy disinflation.

“That’s the narrative that has befuddled me for quite some time,” she said, noting that labor markets remain tight by the Fed’s own measure. “How could that possibly be a green light for an actual pivot to rate cuts after the most aggressive hiking cycle in 40 years?” 

“I don’t think it’s out of the question that the Fed might be cutting next year but not under the current set of circumstances,” Sonders added. “A Fed that moves to rate cuts next year would, to me, only happen through a combination of continued disinflation to or near their target and more than just cracks in the labor market, bringing their other mandate into clearer focus.”

Tied to Labor Market

The Fed views a weaker labor market “as being a necessary condition to keep inflation down. And the current set of circumstances, even if you support a pause … a pause and a pivot are two entirely different things,” she explained. 

As for the pivot narrative, “I always think, boy, be careful what you wish for.” 

The Fed will cut rates again but won’t go back to a zero interest-rate policy, she predicted. 

 “I think that is a ship that has sailed,” Sonders said.

With few or no exceptions, she added, central banks looking at zero or negative interest-rate policies find more negative than positive consequences.

Pandemic Effects in Play

Sonders has frequently noted her belief that the U.S. economy has been experiencing a rolling recession since the COVID-19 pandemic, with different components affected at different times. She suggested that the process isn’t finished yet, citing “long and variable” lags in response to forces like higher interest rates.

“We’re just not past the expiration date on the hits that come at different times,” she said.

An example, she noted, is that the effective mortgage rate is about half the rate for new home loans, as homeowners hold on to properties and mortgages they secured when rates were low.

“There’s still a coming-home-to-roost environment here as it relates to weaker companies, the zombie companies,” Sonders said. “It’s coming on the consumer side of things, admittedly down the income spectrum, into subprime where you’re looking at delinquencies, lateness on auto loans or mortgage loans, and eventually it starts to creep up.”

New data from the National Federation of Independent Businesses supports these concerns, according to Sonders.

“You’ve seen a deterioration in confidence,” with inflation tied with broad labor concerns as the biggest worries for small businesses, she said.

Among other pressures, Sonders noted, excess consumer savings from pandemic-era payments are declining, with perhaps another quarter’s cushion, and paused student loan repayments are resuming this month.

Psychology drives not just markets, she added, but “it drives inflation, it drives the economy, and that … could be one of the things that breaks, is the confidence part” that feeds into inflation and the economy.

Demand for Liquidity

The disinflation occurring along with a massive spike in bond yields has ripple effects, according to Sonders, who suggested that something in the economy could “break” at some point.

“I do worry about the shadow banking system and how much lending has been done there, and that’s where there’s opacity and it’s always hard to know what the thing is that breaks when you have a spike like this in yields,”  she said. 

Sonders added that she doesn’t know enough about the shadow banking system to judge whether cracks are starting to widen.

Turning to rising bond yields, Sonders noted that the speed of that increase matters more than the level. The yield curve is steepening off a deep inversion, and “that’s the recession signal, not the inversion itself.”

That rising rates are coming with a bear steepener — long-term bond yields rising faster than short term — makes the spike in yields “quite unique,” Sonders said.

“It brings back what was being discussed in 1987 too … the speed,” she added. “Is something going to break, which brings you back to that desire for liquidity as we wait to see what, or if, the things are that break. And I think that that’s all part of the story around the demand for quality and liquidity.”

Pictured: Liz Ann Sonders

Dinah Wisenberg Brin

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