Now that U.S. stocks are up nearly 100% since the March 2009 bottom, the bulls are out in full force. That worries Liz Ann Sonders, chief investment strategist at Charles Schwab. Although she thinks the stock market will perform well this year, Sonders’s contrarian instincts tell her that there’s now too much optimism, which could lead to a correction soon. Sonders, who graced the cover of the January 2010 issue of Kiplinger’s Personal Finance (see Interview with Liz Ann Sonders: Listen to Your Portfolio), chatted with us about her outlook for 2011. Here’s an edited transcript of our conversation:
KIPLINGER’S: What are your expectations for the economy in 2011?
SONDERS: I’m still more optimistic than the consensus. The consensus expects gross domestic product to grow 3% to 3.5% for 2011, and I wouldn’t be surprised to see something north of 4% -- at least for the first couple of quarters of the year. In fact, GDP for the fourth quarter of 2010, which will be reported on January 28, could be in the 4% range.
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Why so upbeat? After faltering in the summer, all of the leading economic indicators started to reaccelerate a couple of months ago. The exception is building permits, which are still weak. But that’s not surprising because housing is not terribly stellar at this point. The job indicators are starting to pick up -- for instance, we’re seeing a decline in new unemployment claims. Fourth-quarter consumer spending was very strong. In fact, as of last quarter, real, or inflation-adjusted, consumer spending has surpassed its 2007 high, yet GDP has not. So consumers, who account for about two-thirds of GDP, have actually been stronger than real GDP itself.
What’s behind the comeback in consumer spending? Part of it is frugality fatigue. Consumers have saved, paid down debt and are tired of saving. Part of it is also the wealth effect -- when the stock market goes up, people feel wealthier and they spend more. In fact, in general there’s a 90% correlation between the stock market’s performance in the fourth quarter and holiday retail sales. And when you have a strong market, like we did in the fourth quarter of 2010, you tend to see that translate into stronger consumer spending.
What’s your outlook for the stock market in 2011? For the near term I’m cautious, purely because nearly every measure of sentiment I’ve looked at within the past month or so started to show very high levels of optimism, which tends to be a bit of a warning for the market in the short term. So I expect somewhat of a pullback in the beginning of the year. But then I’m still optimistic for the rest of the year. I think there’s the potential for a significant capitulation by bond investors. And when they finally capitulate, they will move out of bonds and into stocks. We started to see some of that in December.
Institutional investors have returned to U.S. stocks, but will individuals get back into the game this year? Probably not in any kind of major way. But you’re likely to see investors reallocate some of their fixed-income holdings, particularly Treasuries, into U.S. stocks. I also think we could see some reallocation of money from emerging markets into U.S. stocks, based on concerns about China and the potential for it to raise interest rates, coupled with a weaker Chinese stock market.
What’s your outlook for corporate earnings in 2011? Earnings will still do quite well relative to expectations, but the size of year-over-year increases in percentage terms is starting to diminish. It’s just the simplicity of the math since earnings have been so strong. As we move from recovery to expansion and as we start to go into a period of a diminishing rate of earnings growth, the key will be more companies beating expectations for sales growth.
What are the big risks? The euro-zone debt crisis isn’t going away anytime soon. Then there’s the U.S.’s own version of the European debt crisis -- that is, the fiscal problems of state and local governments. It’s not clear whether the federal government will bail out states or municipalities if any default. Another risk is rising interest rates -- a healthier economy should continue to put upward pressure on bond yields. That has not yet been a problem for the stock market because we’re in an environment where stock prices and bond yields have been positively correlated. In other words, rising bonds yields have been met with rising stock prices and vice versa. I don’t expect that to change any time soon. But if we started to see yields pick up dramatically, bonds would start to provide more competition for stocks. However, it would also start to bring into question when the Federal Reserve will have to start raising short-term interest rates. But I’m not as worried about this risk as I am about the others.
What’s your view on Treasuries? It’s not a terribly attractive asset class. We’ve been warning investors for months to be aware of rising yields -- especially if you invest in bond funds as opposed to owning the bonds directly. So investors should be mindful of not being overexposed to fixed income or to Treasuries relative to what their normal plan would suggest is appropriate.
What’s your take on commodities? As with stocks, the universal optimism toward commodities in general and precious metals in particular makes them vulnerable in the short term. There’s a trading component in commodity prices that has little to do with the fundamentals of supply and demand. But the longer-term, fundamental case for commodities is still very much intact, given the growth in emerging markets. So industrial commodities will probably continue to do fairly well. I’d be more concerned about precious metals.
What general advice do you have for investors? Over the past couple of years, asset classes generally moved in tandem. Now, correlations between asset classes are starting to come down. When correlations are lower, diversification tends to help more because some asset classes are doing well and some aren’t. It also increases the benefits of portfolio rebalancing, which is one of our perpetual mantras.
Also, if you’re willing to do your homework, you now have at your disposal a growing number of exchange-traded funds that allow you to invest in asset classes that individual investors historically weren’t able to invest in, such as commodities and currencies. These can be important tools for investing.
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