We know the stock market's looking scary, but where are we in this economic downturn -- near the beginning, or approaching the end?
Are financials like Wells Fargo
Stepping back from the individual companies to get a view of the economy as a whole, I talked with Liz Ann Sonders, chief investment strategist with Charles Schwab
Jennifer Schonberger: Where are we in this recession now?
Liz Ann Sonders: We're beyond the halfway point. My best guess is that sometime in the third quarter of 2009, we'll get the official word that it's over -- now keep in mind, given that it took the NBER [National Bureau of Economic Research] a year to tell us we were in one. The normal span of time between when recessions have ended historically, and when they're declared in the end, has been 15 months. So if I'm right about the third quarter of 2009, we'll probably get the word on that some time in 2010.
Schonberger: Then would you say that the worst is behind us?
Sonders: I think we're in the worst phase right now. I had thought that the worst single quarter would be the fourth quarter in GDP terms, and it was not as bad as expected, because we got that inventory lift. Now, there's nothing positive about that inventory lift. The reason inventories spiked up beyond what was expected, which was a boost to GDP, was because nothing is selling. Inventory is building up on the shelves, and that's not a good story behind what was better-than-expected GDP.
I think we may carry forward some of the severe weakness into the first quarter. In terms of economic news, we may get worse readings in the first quarter. The general comment I would make is that I think we're in the "crescendo" period right now, where the news is for the most part the worst it's going to get. That doesn't mean we "V" bottom from here and we're off to the races; but I think as 2009 unfolds, the news will become progressively less sad.
Schonberger: Relating to your point on the V-shaped recovery, there's been less of a dramatic reaction to bad news as of late. Where are we in the bear market cycle? Are we at an inflection point here?
Sonders: I don't know if we're at an inflection point. I think that when we exited the fourth quarter, we left behind that unbelievably rampant volatility and the investor and consumer mind-set that was in utter "freak out" mode. That was not sustainable. So I think a little bit of a calm has been restored. Now, it's not a calm in a sense that there is optimism, but rather a calm as a function of being exhausted. We're out of that frenzied mode.
It was Armageddon for a while after the whole financial system completely shut down, especially with the Lehman bankruptcy in the fall. It's not Armageddon anymore. We've seen unprecedented stimulus, they certainly have the monetary variety and are coming up with the fiscal variety. If that's having some of its intended effects, we're seeing spreads come down and credit markets are unseizing. So there are some positive signs that some of the worst may be past us.
Schonberger: You mentioned that credit spreads have come down a little bit. Where are we in the credit markets?
Sonders: [Credit spreads are] still elevated. We still need to see private-sector borrowing rates come down more to really get a sense that the economy has any legs here.
One of the indices I look at is the Bloomberg Financial Conditions Index. I like this index because it's kind of an amalgamation of a number of different credit spreads. It also looks at the corporate bond market, as well as volatility in the equity market. Kind of a normal pre-August of this year reading on that index was at a negative 2 level, pretty steadily for about a year, up until September with the Lehman bankruptcy -- at which point it plunged to a negative 10. By far the worst it has ever been. Now it's back up to a negative 4. So we've come back some, but we're not back to normal.
Schonberger: So much of what drove the markets at the tail end of last year was what was happening in the credit markets. Is 2009 for the stock market merely going to be a trading range, as we've seen so far, or do you think things will shape up to be worse than expected?
Sonders: I think 2009 will be volatile -- now, not volatile in terms of percentage moves on a day-to-day basis and the kind of 'flip-flopping' we saw in the fall, but levels of volatility that greatly exceed any kind of long-term norm. What I think may happen is the markets may move somewhat higher. The net of all the volatility in 2008 was horrific returns on the downside. I think the net in 2009 -- and it's important to note that we're not market timers, we don't do market forecasting or year-end targets for indices -- has the potential to start to work its way higher even in the confines of this volatility.
I don't know if Nov. 20 was necessarily the bottom; but I think we're in a bottoming process likely in the context of what is still a secular bear market. I don't know that we've exited the secular bear market. But looking at the rapidity of the decline into the fall, and comparing that to the sort of waterfall declines that we've had in the past, the technical conditions that surrounded what happened to the net percentages of stocks that were trading at new lows versus new highs -- and there are a number of technical and risk measures you look at (the crescendo of weak economic numbers) -- all of those point to the kind of conditions you tend to want to see when the market is finding that bottoming process.
Schonberger: What needs to happen for us to see a meaningful move upward in the market?
Sonders: Probably the most powerful factor behind the potential for a better stock market is the unbelievable $9.2 trillion in cash sitting in nothing but short-term, safe investments like Treasuries, bank and saving accounts, and money market funds. That's equivalent to 96% of the market cap of all U.S. companies. That's so far beyond anything we've ever seen before. There may not be an imminent catalyst to move this mountain of cash, but I do believe this time the market will do what it typically does, which is move in advance of the economic news getting better.
Schonberger: Do earnings have to come back for the market to come back?
Sonders: No, earnings are generally the last to come back. The broad order of things is stocks usually rebound first, then the economy comes out of recession, then earnings trough, and then the unemployment rate peaks.
Schonberger: A three-month chart of the yield on the three-month T-bill shows the yield has risen from basically zero in December, showing that investors are coming out of Treasuries and perhaps other instruments like corporate bonds. What are your thoughts on investing in corporate bonds now?
Sonders: Our recommendations within the fixed-income sphere have been away from treasuries, but not necessarily fully out the risk spectrum. We haven't moved to outperform on junk, but we have said, "Look at higher-quality corporates, look at munis, and look at TIPS. "
Schonberger: If investors have a long-term investing horizon, would you recommend they take advantage of depressed asset prices and buy in now, or initiate new positions in equities?
Sonders: Time horizon is part of the investment criteria that should decide how much exposure an investor should have to a riskier asset class versus a less risky asset class, but that's not all that should be considered. Too often, advice is given to investors with a market-timing approach. In other words, "Yes, the market's cheap. Yes, time to buy." But that's not the right answer for everybody.
We're big believers in strategic asset allocation, which means the asset allocation you have in stocks, bonds, and cash depends very specifically on your own personal circumstances -- your risk tolerance being primary among them. Too often, people tie risk tolerance to their time horizon, but time horizon doesn't necessarily mean risk tolerance. They say, "I have a long time horizon, I've got 20 years before I'm going to retire, therefore I should have the vast majority of my money in equities." You could have 30 or 40 years between now and retirement, but if you have no tolerance to lose any money, then your risk tolerance is very low, regardless of how old you are and how long to retirement.
The most important thing investors should do now, assuming they have a plan, is assess the asset allocation that makes sense for their personal circumstances (their risk tolerance). If you're now way under an asset band of, let's say equities, and your circumstances haven't changed, and your time horizon hasn't changed, then absolutely you should be thinking of putting some money back in. But that's not a blanket answer that's right for everybody. If you had too much money in the market to begin with -- you're about to retire, you just lost your shirt, you need every single dime of what is left in that portfolio -- you shouldn't be buying here. You shouldn't have had that much money in stocks in the first place.
Market pundits base their view on their own view of the market, and not what's right for each individual.
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