2008 was nothing short of a roller-coaster ride, ending in what felt like Disney World's Tower of Terror. However, the ride may not be over, and a fairy-tale ending isn't in sight yet.
The U.S. Treasury continues to focus on shoring up the abysmal fate of banking sector heavyweights Bank of America
To gain insight into how stocks will perform in this "new" investing climate and which sectors to focus on, I talked with Liz Ann Sonders, chief investment strategist with Charles Schwab
What follows is part 2 of a two-part interview series. Click here to read part 1.
Jennifer Schonberger: What are your thoughts on the financials like Goldman Sachs
Liz Ann Sonders: We have a "neutral" rating on the financials; which, to put our view on financials in lay terms, it's kind of too late to sell, but definitely too early to buy. A lot of the individual financial stocks still screen quite poorly, so at an individual level they're not yet signaling that there's enough value that has been created here.
From a top-down perspective, on better market days you're certainly seeing company buying on even the slightest bit of positive news. For example, the day that discussions really started to heat up about the bad bank option for ridding the balance sheets of toxic assets you saw a huge rally. So I think that's the mode we're in. I think you're going to get some monstrous snap-back rallies that may suggest it's downright late in the game to be bailing out of financials; but from a risk-return perspective, we're not imminently looking at putting an "outperform" rating on financials. ...
Normally financials are one of the leadership groups coming out of an economic downturn, but it's less likely that those stocks will be in a leadership position in any kind of medium to long-term time frame. They may lead some short-term rallies, but they're still depressed.
Schonberger: When we do enter the next bull market, which sectors or industries do you think will lead?
Sonders: What we think is likely to happen this cycle is less of a sustainable leadership position by the financials. We have an outperform rating on technology. I still think there's this productivity, tech infrastructure theme in place right now that is likely to pick up steam once federal spending kicks in. We're still talking about globalization as a cycle, which eventually should reverse back in favor of the more traditional cyclicals like basic materials and industrials -- kind of the commodity theme.
Commodities were in an absurd bubble into last summer, and most if not all of that bubble has corrected. I think we're reentering an environment where the stocks and the commodities themselves will trade based on fundamentals and not on ridiculous speculation. So we would also watch the commodity sector. We think that might be one of the first areas that starts to show some definable leadership; and we would view that as a sign that the global economy is finding its footing. So whereas a lot of people view a move back higher in commodity prices/oil prices as a negative because of what it means for the consumer, it may indeed be a signal that we're finding our footing from a global economic perspective.
Schonberger: How does the deleveraging process factor into investing going forward?
Sonders: When you talk about deleveraging, there's multiple facets of deleveraging happening now. There's the shorter-term hedge fund deleveraging, the whole financial system deleveraging, where you're going from 20:1 leverage ratios down to 5:1. In terms of the hedge funds deleveraging and other financial institutions deleveraging, I think the crescendo of that has already happened. We're not finished with the process, but we really saw it happen fast and furiously in the fourth quarter last year.
But there's a bigger aspect of deleveraging that is much more powerful and longer-term, which is the deleveraging of the private sector. Consumers are deleveraging. That is a multi-year phenomenon, and it's having a huge impact on debt paydowns -- the savings rate is skyrocketing. Effectively, the private sector just slammed on the brakes in the fall. Consumption stopped, borrowing stopped, and everyone pretty much all said at once, "I've got to get my financial house in order." So it's the private sector deleveraging that we think has the biggest long-term impact. The impact is probably going to be weaker economic growth, relative to what we've experienced in the last several decades. The government sector is going to step in and represent more consumption -- so we'll see the government stepping in as the spender of last resort, and the Fed as the lender of last resort.
So we think there's more important implications of this private sector deleveraging than the financial sector deleveraging, even though that was viewed to be the most important thing happening as we closed last year.
Schonberger: As the government steps in, does that mean more muted returns going forward?
Sonders: Yes, I think so. Consumer spending has gotten up to about 71.5% of GDP. That's coming down and we think it's going to sustainably come down. Historically, a more long-term norm for consumer spending as a driver of GDP was in the low 60s. We may not go all the way back there. Government spending is going to pick up some of that [consumer spending] slack. My hope is that it doesn’t try to pick up all of that slack because that would be beyond the most pessimistic view at this point. If you look at how much debt is needed to drive $1 worth of economic growth, it's really extraordinary. If you look at the last five decades, in the 1950s it took about a little over a dollar's worth of debt to drive a dollar's worth of GDP. Each decade since then you've seen that number go up. This decade so far -- and we've only have the data through the third quarter of 2008 -- it's taken $5.30 of debt to drive one dollar of GDP. That was not sustainable. That's why we hit this brick wall. The economy is no longer going to be driven by debt-fueled consumption.
Schonberger: The stimulus is still being worked out, but there are concerns it may not help. What are your thoughts on the stimulus plan?
Sonders: They're going to pull out all the stops to juice the economy at all costs. I wish they wouldn’t. I wish they'd say this is the medicine we have to take to become healthier. If it means a more subdued pace of economic growth, if it means more savings, less consumption, less debt, I think that’s a wonderful thing. ... Recessions are cleansing processes and the excess that led into this one was huge and therefore the cleansing process is going to be longer and more painful. Part of me wishes we would get real with that reality. ...
I would rather see more natural, free-market solutions to this, especially if the solutions being proposed are trying to stimulate excessive borrowing and consumption again, which are what got us into this in the first place.
Schonberger: What's the silver lining in all of this?
Sonders: The silver lining is that when we come out of this we have a healthier private sector. We may not have a healthier government, and that's the problem. It's hard to get everyone healthy at the same time, because at this point you need the government to step in and at least attempt to fix what ails us. But we're going to have a healthier consumer. We couldn’t go in perpetuity with a negative savings rate. You can't fund yourself like that. To me the ultimate silver lining is a more financially fit population.
Schonberger: What’s the next asset bubble?
Sonders: I think we're in one with Treasuries. I don’t that there's any catalyst that's going to imminently burst that bubble, but I think we have a Treasury bubble.
Schonberger: What happens when it bursts?
Sonders: You’ve got a tremendous amount of money sitting in an asset that is yielding next to nothing. Even out the maturity spectrum for longer-term Treasuries, with the exception of the 30-year yield, you're still looking at sub-3% yields, which if we get back to any normal inflation environment and those yields don’t continue to rise, you're going to look at real yields that are negative. This is not something that's going to last forever. That much money is not going to be willing to sit and do nothing. I think what will probably be the biggest catalyst to get a lot of that money to come out is simply better returns showing up in other asset classes, because investors are performance chasers.
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