Liz Ann Sonders on What to Watch This Earnings Season

Liz Ann Sonders, chief investment strategist at Charles Schwab, returns to this podcast to offer her perspective on what investors should be watching this earnings season, as well as:

• The unlikely start to her career in investing.
• Key macroeconomic data she and her team at Schwab are focused on.
• Her question about crypto.
• One idea to improve the odds of people achieving financial independence.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

This video was recorded on Jan. 15, 2023.

Liz Ann Sonders: I think the actual reports for Q4 will be important, as they always are, but I think the forward guidance becomes even more important in this environment. Not just whatever guidance they might provide on earnings per share, so we can get a sense of whether the bar is still too high for 2023, hasn't come down enough, maybe has been cut enough, but specifically, profit margins, and to your point, the layoff situation.

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Chris Hill: I'm Chris Hill and that's Liz Ann Sonders, the chief investment strategist at Charles Schwab, weighing in with her thoughts on what investors should be watching during the earnings season that just kicked off. I caught up with her last week to get her thoughts on the market, valuation, risk tolerance, crypto, financial independence, and a lot more.

But I began the conversation by asking about her career path. There are people who know early in life exactly what they want to do for a living. But Liz Ann Sonders went to the University of Delaware and studied international relations -- not exactly what you would expect to be the field of study for someone who ended up being one of the most influential market strategists in America. My first question was, back when you were in college, what was the plan? 

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Liz Ann Sonders: I didn't have a plan. When you said there are people who know very early on in life exactly what they want to do and do it, I was decidedly not one of those people. I really didn't know what I wanted to do. The international relations degree really was a double major in political science and economics. That was the program of study, my first two-and-a-half years until they developed the IR program. I knew that when setting up the double major, because that represented the prerequisite. In more practical terms, that was the backdrop, and I felt that that was just broad enough that it kept lots of different avenues open, given I didn't know what I wanted to do.

The only thing I really knew I wanted to do was live and work in New York City. When I got out of undergrad, my grandfather was still living in the city, and I essentially just pounded the pavement, got connected with an entry-level head hunter, and interviewed at numerous different firms across many industries, and just happened to really connect with the people at Zweig/Avatar, and something spoke to me. I took that job, then went to graduate school at night starting a year later while I worked full time. They paid for it. That made the decision easy. I was there for 13 years, and have essentially been at Schwab since then. Basically, two companies in 37 years, which is not common on Wall Street.

Chris Hill: Absolutely not common, in general, and particularly on Wall Street. What was it in those early days that really turned the investing light on for you, and made you think, "Oh, not only is this interesting to me, I think this is what I want to do"?

Liz Ann Sonders: What's interesting about the answer to that question is, in advance of the first interview I had with Zweig/Avatar, and then in between the first and second interviews, I did research on the company, on the founding partners, one of whom was the late great Marty Zweig, which, of course, this was in 1986. So doing research then was going to the library, on microfiche, literally scrolling the wheel through newspaper clippings. There was no Google, there was no internet. It was a bit more of an arduous task at the time. But I was fascinated by Marty. For lack of a better word, he was very much a guru at that time -- was incredibly well-known, had started one of the earliest ever, if not earliest, hedge funds, which is still ongoing even though he passed away a number of years ago -- the Zweig-DiMenna partnership. Then there was mutual funds. He had the best-selling investment newsletter at the time. And the Avatar side was the institutional money-management side.

That's the side I started on, but I was always fascinated by Marty's top-down work. He created the put-call ratio. He coined the phrase "Don't fight the Fed." He coined the phrase "The trend is your friend." He developed numerous breadth-type models. There's this wide breadth thrust that technicians follow. So even though I was ultimately managing money on the Avatar side, I was always much more interested in the top-down, big picture, 30,000 feet. And when I left in '99 to join US Trust, which only several months later was acquired by Schwab, I was then quickly adopted by the parent company, as I like to say. And one of the things they wanted to do was create this position of chief investment strategist that had not existed at Schwab before. They asked if I was interested, and that was my foray from, essentially, the world of bottom-up stock picking to top-down macroeconomic and market analysis. That was 23 years ago.

Chris Hill: That's great that you were able to figure out pretty quickly what area of investing you were most interested in. I want to stick with the Schwab part of this for just a second, because I found this quote of yours from an interview you did a few years ago where you said, "Most strategists make short-term predictions about the market, but that's not what we do. We think investors need to figure out where they are on the risk spectrum, and then we help them customize their allocations from there. We try to foster the notion of long-term discipline so that our clients aren't constantly changing their investments based on the short-term market prediction."

Obviously, love the focus on the long-term discipline and not basing things on short-term market moves. I am curious though: How much of a challenge is that in terms of helping people figure out their risk tolerance? Because in my experience, which is not nearly as extensive as yours, but in my limited experience, the majority of people tend to out of the gate overestimate their risk tolerance. There are some people who maybe underestimate it and they're too conservative for their own good, and it's really a minority of people who can nail what their risk tolerance actually is.

Liz Ann Sonders: You're right. Keep in mind that I don't work directly with clients one-on-one. The work that I and our team do as well as on the fixed income side of our world and the international side of our world, is very big picture. But it's a great question. The way I often frame it, and the way I talk in broad terms to large groups of clients about it is, ideally, you figure this out before the market helps you figure it out. Which is, is there a narrow or wide gap between your financial risk tolerance and your emotional risk tolerance? The financial risk tolerance is arguably the easy part of the process, where you figure out time horizon, and age, and maybe past experiences, tax bracket. Are you looking to just appreciate the portfolio, or do you need to live, in part, on the income generating from it, etc.?

Those questions are generally easy to answer, and you can come up with your financial risk tolerance and then what a structure of a portfolio might look like.

It's the emotional risk tolerance -- and sometimes you don't realize if there's a yawning gap between the two, it tends to come because of a tough market environment that then has your emotions kick in and override your financial risk tolerance. And that often leads to mistakes, perhaps in both directions. Too much aggressiveness when things are going well, and then panic and fear and then missing out on the eventual recovery. So that, I think, you're right, it's the toughest part, but I think framing it in an emotional versus financial risk tolerance. I think sometimes investors, even without maybe a long experience of dealing with market volatility, is maybe think about other aspects of their life that might bring in the same concept, where you can get a sense of -- does the heart act differently than the head in other important areas of your life?

Chris Hill: Over the past year, let's call it, investors, I am certainly one of them, have probably paid more attention than previously to data points related to inflation, the Consumer Price Index, the Producer Price Index. They're so much more in the mainstream narrative now than they were really in the years prior. I'm curious how important you think they are in terms of everyday investors, and because of all that oxygen going to inflation over the past year -- rightfully so -- what is an under-the-radar data point that doesn't get as much attention that you think investors might want to start paying attention to?

Liz Ann Sonders: Sure. The inflation data that we're barraged with these days is not terribly different data than has been the case in decades past. It's just it matters more because it's much higher, and the reaction function of the Fed is having a significant impact on the market, as it relates to, how does it matter to investors? Why does it matter to investors? At the market end of things, we're in a "don't fight the Fed" kind of environment.

We're in a unique period of time, actually, where to some degree the market is fighting the Fed. Or maybe, put more precisely, the bond market is fighting the Fed, and the structure of the bond market now, with the big drop in longer-term yields, is essentially sending a message that either the Fed is going to be able to pause and ease policy sooner than what they're telling us they're likely to do. Or the hit to the economy is more significant than what's built into expectations, and that's why you have such an inverted yield curve.

Maybe the stock market is keying more off what the bond market is saying than it is off of what the Fed is saying. That said, if the reason why the bond market is fighting the Fed is because growth is going to slow more significantly, I don't think that that's priced into the market. We're in a bear market. At the worst, the S&P was down 35%, so it's clearly not the case that the market has been whistling past the graveyard of all this stuff we're dealing with. It's just a question of does it get worse from here?

The inflation data -- we have seen better and better readings pretty consistently since the peak in June. Not anywhere near yet to the Fed's target, which is somewhat arbitrary, but it is what it is. That is the target. For now, that's what they're saying. From a consumer's perspective, inflation is a funny thing, because everybody's inflation rate is different depending on ... especially in this environment where the rent component of a metric like CPI is still going through the roof.

Now, it's an imputed rent component, and it doesn't really track the real economy rent indexes, things like Zillow and Redfin and RealPage, all of which have rolled over, but it takes a while for it to finally work its way into that CPI data. But if you are not renting, you own a home, but you're not paying a mortgage on it, an adjustable mortgage. For example, like my parents, my parents are elderly, 85 and 92, and they don't own a home anymore, they live in assisted living. It's a controlled increase. They're getting a big COLA adjustment with their Social Security. They're not grocery shopping, the meals are paid for. So they don't experience -- they don't drive anymore -- the kind of inflation that somebody who is renting, or has a variable mortgage rate, or is driving an hour to work and has to pay for gas and has to heat their homes. The reality is everybody's inflation rate is different. We just have these standard metrics that we use to measure it.

Chris Hill: I know you and your team at Schwab focus on macroeconomic data. I am curious, however. Just in this month, we've heard layoff announcements from businesses like Amazon, Goldman Sachs, Salesforce. When that news comes across your desk, what do you and your team do with it?

Liz Ann Sonders: Well, here's one thing we've done with it that I think, and it goes back to the second part of your last question, which I didn't directly get to, which is what might people be missing or what are you looking at that's to maybe not quite on the radar screen. Just thinking about the most recent jobs report, one of the specific metrics that comes out every month with the report that went down was wage growth, and that was what the stock market, anyway, seemed to key on. OK, wage growth is coming down. That, maybe not imminently, gives the Fed the green light to start moving toward a pause or easing policy, but at least that's not continuing to accelerate.

The problem with looking at that as a measure of wages is it's an average. What's been happening very recently, to your point, a lot of the big layoffs are of people up the wage spectrum. The two segments within the Bureau of Labor Statistics breakdown by industry of the payroll data. They give us an aggregate every month. The two in the negative column are professional business services and technology. So what happens when you take a larger swath of bigger numbers out of wage data, it brings the average down, somewhat artificially suggesting less wage pressure. Conversely, if you go back to the April month of 2020, when we were deep in the worst part of the pandemic, everything was fully locked down, 20 million jobs lost on a monthly basis. Wage growth showed that average hourly earnings was up more than 8%. No one in their right mind thought we were in a wage boom in that environment. It's just the numbers that were coming out of the average, en mass, were the lower numbers because it was down the wage spectrum. It was retail, and leisure, and hospitality, and younger workers. That artificially biased the wage number up.

You had the opposite effect when things started opening back up. You saw a massive plunge to an incredibly low level of wage growth because a lot of lower numbers were coming into the average. I would say that with all of this data -- inflation data, wage data, jobs data -- you've got a peel at least one layer of the onion back.

In addition, wage growth is still healthy, although down a little bit, but hours worked are being cut quite significantly. So your wage times your hours worked equals your weekly pay. Weekly pay has been sinking like a stone, and it may be reflective of the unique environment we're in where companies, especially those that really fought hard to bring in skilled workers and they may be more hesitant to let them go, but they are cutting hours. That's indicative of maybe a little more weakness being reflected broadly, via labor market statistics, than if you just simply looked at a payroll number.

Then the last thing I'd say is, the payroll statistic is part of the establishment survey. You can't calculate the unemployment rate from that. There's the separate household survey that's done. That's where you calculate the unemployment rate. That had a huge jump of more than 700,000 new jobs. They were all part-time. Multiple-job holders are going through the roof. That is not indicative of a strong economy. And so what can happen is, if you or I fall on hard times and we have to take on a second job, if we were part of the household survey, I might say "Yes, I'm now working part-time at Target." That additional job that me, the one person, has could get picked up in the payroll survey as a new job even though it's just a second job for economic reasons that someone with an existing job had to take on. Another example of looking at the details of the data, especially in an environment like this.

Chris Hill: I want to get your thoughts on the earnings season that's just about to kick off, but before that, we've been around long enough to remember not only the dot-com implosion, but also the fact that there were businesses at the time that really were just ahead of their time. I think about a business like Webvan, where it's "well, yeah, it didn't work in '99, 2000, but internet-based food delivery is all over the place now."

I'm curious: Are there things that you see right now that you have a similar thought, where you think, "This isn't working right now"? It can be an investment device like a SPAC, or it can be a trend like cryptocurrency, just to pick a particularly hot topic of late. Are there things that you think...?

Liz Ann Sonders: I think both of those are good examples. I think what SPACs allowed companies to do at a time when they were more popular and there was more interest, is make forward statements. And that only is important for a company that essentially has no current profits, has no prospects of current profits, but they can generate some hype by making forward statements, promises, whatever you want to call them, which is very different than a company going through the traditional IPO channel, which has much more regulatory scrutiny. It has to be a fact-based, basically historical analysis of things.

And I think in conjunction with interest rates going up as dramatically as they have, and the unleashing of price discovery, the return of the risk-free rate -- I think that contributed, to some degree, to the demise of SPACs. Price discovery also has kicked in with regard to things like crypto. I've always been a skeptic -- not a loud vociferous skeptic, I'm not enough of an expert -- but, known as a crypto skeptic. And what I've always said -- and I've always wanted to avail myself of people who have much greater knowledge than I do. This is not a dogmatic, dig my heels in and say, "This is nonsense, I'm not even going to listen to the other side."

But throughout the years that it was so hyped, the question I would always ask, yet I would never get a cogent answer to or even a consistent answer to was: "What problem is this solving for?"  More people I think are asking that question now in hindsight, or: "What's the use case?" That doesn't mean there isn't something brewing in terms of ... whether it's blockchain or, more broadly, digital currencies, trying to bring the world of the unbanked into the world of being banked in some form or another.

All of those are really important, but crypto became fueled by the unique characteristics of the COVID environment, and being in lockdown, and free trading, and bells and whistles, and "get rich quick," and FOMO.

Chris Hill: And possibly some degree of fraud. 

Liz Ann Sonders: Gee, I don't know. I hadn't heard anything about fraud in that space. I'll have to maybe do a Google search and see what you're talking about. [Laughs] Yeah, and some fraud.

Chris Hill: In terms of the earnings season, we're obviously going to get details on how holiday retail went. Possibly more talk of layoffs or certainly questions on analyst calls of layoffs. What are you and your team going to be watching to give you an indication of where things are going over the next few months and possibly through the rest of the year?

Liz Ann Sonders: I think the actual reports for Q4 will be important, as they always are, but I think the forward guidance becomes even more important in this environment. And not just whatever guidance they might provide on earnings per share so we can get a sense of whether the bar is still too high for 2023, hasn't come down enough, maybe has been cut enough. But specifically profit margins, and to your point the layoff situation. There have been so many high-profile layoffs either announced or started in the case of Goldman Sachs, and given that the financials are first out of the blocks, listening to see whether they affirm or suggest that Goldman is more of a one-off situation, and this is not industry specific more broadly. But many of these big financial companies obviously are really tapped into the consumer and can give a very good perspective on the consumer -- the use of revolving credit, balances, savings rates, and consumption trends that they can pick up from what they're seeing on the consumer side of their business.

So certainly in the early part of the season, that's what I'm going to be watching for. But it is the case that right now, the expectation is that Q4 for the overall S&P, inclusive of the energy sector, will be in negative territory year over year. And I think right now, 2023 as a calendar year still has a positive expectation relative to 2022. I think that's unlikely. I think we end up in 2023 or at least the first half of the year ... so I think if Q4 is negative, I think at least a couple of quarters thereafter are also negative in year-over-year terms before we could possibly start to see some stabilization. I think the path of least resistance for forward estimates is still down.

Chris Hill: I'm going to close by giving you a magic wand. You get to wave it with this power in mind. You get to wave a magic wand to do one thing that improves the odds for the general public's path toward financial independence. It could be financial literacy in schools; it could be mandating that retirement plans all have to be opt-out instead of opt-in. What are you doing with your magic wand to improve the financial picture for the average person out there?

Liz Ann Sonders: Well, I don't know that I would have answered it this way if you hadn't touched on it. The fact that we do not teach financial literacy, even at the high school level, let alone earlier than that, I think is such a travesty. I remember, I think my daughter, she's my youngest, she's 23 now, but it was either freshman or sophomore year in high school and she spent four hours one night drawing and detailing a map of ancient Mesopotamia. And I knew at the time she had no idea -- and when I say "financial literacy," I made myself a total pest with the principal of my kids' high school about this.

And she consistently would come back and say, "Liz Ann, we've got this stock-picking club." And I said, "That's not what I'm talking about." I'm talking about how a credit card works; how taxes are taken out of your paycheck; compound interest; what's an IRA; what's a 401(k). The basics that we just don't teach, and they couldn't be more important. I'm not suggesting get rid of arts, or history, or English, but come on. That should absolutely be a key part of the curriculum so that it's just embedded at a younger age, and you don't get like my daughter, "Wait, I don't understand all the stuff that was taken out of..." her first real paycheck."

Chris Hill: Well the Ancient Cartographers Association is going to be coming after you, Liz Ann.

Liz Ann Sonders: I'm sorry. Let's do both. I'm not saying let's not ever draw Mesopotamia again, but let's do both. And I said even let's call it "life economics." There was home economics when I was in high school, and other trade programs. Let's call it "life economics."

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Chris Hill: As always, people on the program may have interests in the stocks they talk about, and the Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. I'm Chris Hill, thanks for listening. Remember, the market is closed on Monday for the MLK holiday, so we'll see you on Tuesday.