Sonders: Stock Bull Market Intact

Despite the fact that Liz Ann Sonders flew into Florida just this morning, she was well aware of the bearish bias of many of the macro presenters at this year's Inside ETFs conference.

While not a raging bull by any means, the chief investment strategist for Charles Schwab provided a much more measured and cautiously optimistic view of the economy and markets in her closing keynote address.

Still Cautious, But Recession Unlikely

Sonders began her presentation with a quote from famed investor Sir John Templeton, who once said that "bull markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria.”

Sonders spent much of her talk explaining why she believed that the bull market was still alive and most likely in the "mature" phase of Templeton's life cycle.

While she was cautious on the near term, she certainly didn't think the economy was in as bad shape as many believe.

"I don't want to dismiss any of the concerns out there about the global economy, but if you look at the data, it's not as bad as the doom-and-gloomers suggest," she said.

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Global leading indicators are actually picking up, according to Sonders, while U.S. leading indicators show only minor stress. These indicators, based on economic data―which suggest a 10% risk of recession―contrast with market-based indicators such as stock markets, credit spreads and the yield curve, which put the risk of recession at 50%.

Putting the two together, Sonders put the risk of a U.S. recession at 25%. In fact, "leading indicators show we probably have a ways to go before the next recession," she said.

The big question, according to Sonders, is whether the weakness in manufacturing pulls down the rest of the economy. In her view, it's won't, and the 88% of the economy that is service-related can weather the slowdown in the 12% that's tied to manufacturing.

While her talk was mostly about the United States, Sonders did mention China, about which she said she isn't particularly worried about: "We're in the soft-landing camp, not the hard-landing camp." Moreover, U.S. exports to China are minimal as a percentage of GDP, thus the risk to the U.S. economy isn't very big.

NOT Another 2008

In her analysis of the stock market, Sonders was firm in her conviction that the current situation was unlikely to result in a crisis-driven crash.

"This is not another 2008," said Sonders. "This may be another 1998 or 2011 based on market behavior."

The health of the financial system, leverage of the financial system and exposure to the problem area [energy] in the banking system are all in better shape than in 2008, in her view.

Nevertheless, Sonders sees the recent market volatility as dissuading the Federal Reserve from tightening anywhere close to four times this year, as it had recently projected. Instead, the market's forecast of one or two hikes, at the most, is probably close to what will actually happen.

And that's a good thing for the stock market. Slow tightening cycles have historically been better for stocks. In those cases, the market is, on average, up 10.6% in the year following the Fed's first rate hike.

That's in contrast to fast rate-hike cycles (in which the Fed raises interest rates at every meeting), where the stock market on average has fallen 2.7% in the year following the first hike.

Explaining the pattern she noticed since the bull market began, Sonders says that financial conditions have tended to tighten, making the Fed back off before financial conditions then loosened, allowing the Fed to come back in: "This loop has been going on for some time and it will continue," she said. "A lot of it is just investor sentiment swirling [up and down]."

Secular Bull Market On Track
From a big picture perspective, Sonders believes the U.S. stock market is still in a secular bull market. However, these secular bull markets "can have a lot of drama embedded in them," she said. "Within secular bull markets, you can go through cyclical bear periods that have higher likelihoods of corrections and higher bouts of volatility."

Based on her analysis, that's the phase we've been in recently―though that is likely to change at some point as the bull market resumes.

In fact, the year that follows a weak year in a secular bull market tends to have strong gains. Given 2015's poor performance, 2016 could thus turn out to be a good year for markets.

Stocks Still Unloved

On the whole, Sonders’ presentation suggested that while she saw the potential for more near-term volatility, longer term, she sees a bull market that may continue for some time.

Valuations are not excessive, with the forward P/E for the S&P 500 slightly below its historical average.

Perhaps most importantly, stocks remain unloved. "Zero net new money has come into domestic funds [ETFs plus mutual funds] since the financial crisis; that's never happened before," she said.

“Moreover, the level of bullishness based on the AII Sentiment Survey is at the lowest level since 1987," she noted.

That all adds up to a market not anywhere near euphoria, which is the final stage of a bull market, according to Sir John Templeton.

Contact Sumit Roy at [email protected].