The four-week rally for the Dow hit a speed bump last week, as investors tried to process the Federal Reserve's future plans for more rate hikes. The FOMC, of course, raised the federal funds rate by another three-quarters of a percent—the fourth time in a row it's done that—and that was pretty well telegraphed. But Fed Chair Jerome Powell's tone and temperature on the size and pace of future rate hikes put a chill in the markets, especially for those investors who were not wearing a sweater.
No pivot, no pause, which means the Fed's terminal rate—the level at which the Fed is expected to stop raising interest rates—is now well north of 5%. With its latest rate hike, the federal funds rate is between 3.75% and 4%. To quote Powell, we still have a ways to go. All of that may have taken the wind out of the sails for U.S. markets, as the Dow shed 1.4% on the week, while the S&P 500 and Nasdaq fell 3.3% and 5.6%, respectively, to break two-week winning streaks. Worth noting, though, that buyers came back in on Friday—and they've been doing that for the past few weeks. So maybe there's a little more conviction and support than there was back in August and September. We'll see if that sticks, this week.
For everyone out there hoping that the Fed is going to suddenly change its mind and pivot its monetary policy stance and start cutting rates again, be careful what you wish for. A sudden slashing of the federal funds rate by the FOMC is usually a response to a major crisis in the economy or capital markets. And going all the way back to the 1950s, every time the Fed was forced to pivot and start slashing interest rates, deep bear markets followed. As investors, we want to be like Goldilocks when it comes to the federal funds rate: not too hot, not too cold—just right.
On last week's show, we talked about the deterioration of market cap and influence that big tech stocks have had on the S&P 500. They went from representing more than 23% of the overall weight of the index to under 17% amid this broad-based selloff. But through it all, Apple (AAPL) shares have been more resilient. Felix Salmon at Axios points out that at one point last week, Apple was worth more than Amazon, Meta, and Alphabet combined. And, if we look inside the charts, shares of Apple are down only about 8.5% percent in the past year. Compare that to the 48% drop for Amazon (AMZN), the 41% drop for Alphabet (GOOGL), and the 73% nosedive for Meta (META), and the separation becomes even more stark.
In a lot of ways, Apple has become somewhat of a safe haven for investors, large and small, over the years. In fact, if we stretch the charts back five years, Apple shares are up 220%, compared to just a 64% rise for both Amazon and Alphabet. Meta shares are down nearly 50% in the same time frame. There's a reason Apple, along with Microsoft, are two of the most widely-held stocks in ETFs, mutual funds, pension funds, and individual investor portfolios. And you know who else owns a lot of Apple stock?—Warren Buffett's Berkshire Hathaway. Berkshire is one of the top shareholders of Apple, owning about 6% of the shares outstanding.
Meet Liz Ann Sonders
Liz Ann Sonders is Senior Vice President and Chief Investment Strategist at Charles Schwab. She has a range of investment strategy responsibilities including U.S. market and economic analysis, and asset allocation recommendations for individual, corporate, and institutional investors. She is a contributor to Schwab’s advice publications and videos, and a keynote speaker at many Schwab client and corporate events.
Liz Ann has been named one of SmartMoney’s "Power 30," their list of the most influential people on Wall Street; the best strategist of the year by Kiplinger’s; one of the “25 Most Powerful Women in Finance” by American Banker/US Banker; and one of the "50 Top Women in Wealth" by Wealth Manager/AdvisorOne. Most recently, she was named to the "IA 25" by Investment Advisor, their list of the 25 most important people in and around the financial advisory profession.
Liz Ann makes regular TV appearances on CNBC, Bloomberg TV, and Fox Business News, and is regularly quoted in publications such as The Wall Street Journal, Barron’s, and The New York Times. Liz Ann earned a BA in Economics and Political Science from the University of Delaware, and an MBA in Finance from Fordham University’s Gabelli School of Business.
What's in this Episode?
This episode of the Express is presented once again in partnership with Charles Schwab. What makes independent advisors different? The promises they can make. They promise to put the financial well-being of you and your family first, to serve, not sell; to make your relationship with them one of partnership and trust, and to be a fiduciary all of the time, not just some of the time. And Charles Schwab is proud to support these independent financial advisors, who are passionately dedicated to helping people achieve their goals. Learn more or locate one near you at findyourindependentadvisor.com.
Expectations—we all have them, especially investors. But this year has taught us that expectations can be dangerous, especially if we continue to believe that stock and bond market returns are guaranteed, the economy will normalize, and we can continue to deploy our capital like we've done for the past 12 to 13 years, expecting the same results. Newsflash: we can't. But we can reposition ourselves for the new, new normal, and get back on track with our investing plans—as long as we have a plan.
Liz Ann Sonders has been one of the top market strategists counseling investors to do this since last year. And if we've paid attention, we've been able to navigate this new normal with less anxiety. Liz Ann is the Chief Investment Strategist and a managing director at Charles Schwab and a frequent guest on The Express. She joins us from the Schwab Impact Conference. Welcome back, Liz Ann, and so good to see you.
Liz Ann: "Oh, nice to see you, too. Thanks as always for having me. I love our conversations."
Caleb: "You are at Schwab's annual impact conference, where thousands of financial advisors and investors gather every year to get smarter insights to take back to their clients. What are advisors hearing from their clients, and how is Schwab counseling them?"
Liz Ann: "What I'm finding is that the questions that we hear advisors are getting most from clients—beyond the obvious of "when will this bear market end, and how do we deal with an environment where we had both stock and bond total returns in negative territory in the first half of the year, where are the opportunities?" But there still seems to be very much a macro focus to the questions—big picture questions around what the end game is in terms of central bank policy, concerns about debt, and whether we're experiencing 1970s-style inflation. One of the questions that I get are not directly market-related: valuations, earnings sector—it's more big picture, and the questions are definitely more about concerns, and less about opportunities."
Caleb: "I talked about expectations at the top, and we've had more than a few of them dashed this year, especially as it relates to monetary policy, the Fed, and some of the macro issues you just mentioned. The Fed said inflation will be transient—it's not. We expected the Fed to pivot and ease back on rate hikes—it hasn't. We expected the Fed to pause, or at least say that it might—it hasn't. So what should we realistically expect as investors for the next six to 12 months?"
Liz Ann: "First of all, you know, you used the broad collective "we" in those three things. I know, us at Schwab, personally—we're not in the pivot camp. In fact, I think the narrative that really developed in mid-June, when the market had its initial low leading to the two-month rally, was on this hope or assumption of a pivot."
"Personally, I thought that narrative made no sense because—certainly at that time—what was meant by "pivot" was the Fed going from a very aggressive pace of rate hikes to rate cuts. And why I thought that assumption made no sense was that it was wrapped with a bullish wrapper. And in my mind, an environment that would give a green light for the Fed to go from an aggressive hiking cycle to cutting, would be one of much weaker economic growth than what we were seeing at that point, along with more significant deterioration in the labor market. So I didn't think that that story made a lot of sense."
"Then Powell came out in August, at the Jackson Hole Economic Symposium. He pushed back on this notion of pivot. And then, what I think has fueled the market higher more recently, was the hope for a step-down, you know, another term being used. That's in essence, what was seen in the FOMC statement. But Powell had to, again, quickly come out and push back on this notion that a step-down was the next step to an eventual pivot."
"And what I think Powell has yet to fully convince the market—investors of—is that, yes, maybe the speed of getting to the final stopping point—the terminal rate—will be a little slower. But, what I don't think he's fully convinced participants of yet, is that when they get there, they're going to stay there for a while. So I think that is yet to be digested by the market, but should be, because they're being really clear that when we get there, we're going to stay there for a while. If they want to avoid the fits and starts of monetary policy that caused the 70s to become what Volcker had to contain in the early 80s."
Caleb: "Yeah, great point. And when I say "we," I mean maybe the broader "we," but you have been very consistent in saying that we're not going back to the way things were, and this is going to be the scenario, at least for the near term. And we know from the Fed's meeting last week—the FOMC's meeting last week, that the terminal rate could be north of 5% now, and we're still at least a percentage point, if not more, away from that. So that means a few more rate hikes, earnings..."
Liz Ann: "...and Caleb, let me just say one more thing that's interesting to think about. We may have spoken about this before—the prior view of this thing called the "Fed put," that in the past, if markets were rioting significantly enough, or if market weakness was significant enough, like late 2018, the Fed would step in and they would pivot, and they would change policy, and that eased pressures. But because they're now battling a 40-year high in inflation, the Fed put, as it's been called, has been put to bed."
"But I wonder whether we now have some version of a Fed "call," where now the Fed has to push back on too much optimism, because a strong rally in the market and an easing in financial conditions is not what the Fed wants right now. They want tighter financial conditions. So Powell has to sort-of jawbone against optimism, which is a very different environment from the modern era of the Fed up until recently. And I think we have to get used to a different reaction function on the part of the Fed."
Caleb: "That's such a great point. And newer investors, or people that are newer to investing in the last 10 to 15 years—they don't really know from that—they haven't experienced this. You've got to go back, again, to the Volcker Fed—you've got to go back a ways to feel that, and it creates a different return environment for different asset classes."
"Let's get to earnings for a second, because you've written about this. You've written about the labor market as well. And it's been one of the few so-called sturdy legs of the economic stool in the past couple of years. It's one of the reasons the Fed and others say we're not in a recession, and we wouldn't know it if we were until we've already been through it. But you see cracks in the labor market that could turn into real chasms. What are they, Liz Ann?"
Liz Ann: "So I think there are some of popular headline labor market indicators—the jobs report that we get every fourth Friday. The first two breathlessly reported headlines that come out of that, at 8:30 a.m. Eastern Time, is the payroll number—jobs gained or lost in the prior month, and the unemployment rate. Those are the metrics that are often used to describe the health of the labor market, but there are things that happen well before a change in payrolls and a change in the unemployment rate."
"The unemployment rate is not only a lagging indicator, it has one of the greatest lagging periods of any economic indicator. So you need to go back in the process to see where things start to deteriorate. Ultimately, it will get to headline numbers like payrolls and the unemployment rate. Layoff announcements are one of the first things to be reported. Actually, there's even something that precedes that, which are hiring freezes. There's a great increase in anecdotal evidence of hiring freezes, and more commentary about that during earnings season. It doesn't always tend to be a formal announcement, but you can pick up snippets from what companies are saying."
"Then there are the layoff announcements, and Challenger, Gray is the keeper of that data. I think it's four months in a row now, or four out of the last five months, that we've been in double digit gain territory year-over-year. In this case, a gain is not a good thing—it's higher layoff announcements. And of course, the higher layoff announcement comes before the layoffs. Then once layoffs begin to occur, it starts to hit unemployment claims. So you have to understand how these things filter through. Now, it may be a unique environment, and I think it is. Companies are less quick to ramp up the layoffs, because we were in such a tight labor market and it was so hard to find talent."
"And as a result, we may find that the job losses in this downturn, recession—whatever you're going to call it—might not be as significant. However, one thing you can track is hours worked. So if you're a company that employs hourly workers, and demand is slowing and business is slowing, and if you don't want to lay people off, then you shrink the number of hours that are needed. So even though wage growth is up, if you look at weekly earnings—those have started to come down because the "hours" part of the equation has started to shrink. So these are cracks—they're not suggestive of a massive implosion coming in the labor market."
"And then the household survey, from which the unemployment rate is calculated—that has picked up the fact that there's multiple job holders now, more part-time work for economic reasons where there's been a decline in full-time work. So it's just peeling back a layer or two of the labor market onion, and you see that there's a few dark spots that bear watching. And here's another thing—the Fed wants to weaken the labor market, and they're on a mission to do that. They'd love to perfectly thread the needle and just squash job openings, without causing an increase in the unemployment rate. But even Powell concedes that the unemployment rate needs to go up for them to accomplish their goal."
Caleb: "Yeah, which seems counterintuitive because part of the Fed's dual mandate is maximum employment, and we're kind of there, right?—between three and 4% unemployment. But again, to your point on all of this, the headline numbers are in the rearview mirror. You have to look at the private payrolls. You have to look at what's happening in terms of hours worked. and in terms of wages. And we're in such a peculiar spot right now."
"Let's get to the investment side of this. Retirees and pre-retirees—they felt pain every which way this year. The 60-40 portfolio is having its worst year in history. But now, given rate hikes, there are finally returns in fixed income, money markets, CDs, municipal bonds. It's a good old-fashioned tortoise-versus-hare type of investing where "slow and steady" makes a lot of sense right now, Liz Ann. How important is it for older investors to re-embrace that strategy, particularly if they veered away from it?"
Liz Ann: "Well, you know Caleb, what's interesting is—I think back to two years ago, when all we would hear was, "I need yield, I want to get yield, where can I go for yield?" I'm getting nothing even out of, you know, the 10-year Treasury, which at its low yielded less than 0.5%. And then, when you got the initial surge in inflation, of course, and you subtracted that from nominal yields, you were deep in negative territory. But now, even a three-month Treasury bill yields more than 4%."
"And yes, the process of rates going up meant that bond prices were going down, so the total return got slammed in the first half of the year. But it's now bred a better yield environment, and more opportunities to be active on the duration front, and maybe lengthen duration a little bit, lock in those higher yields for an extended period of time."
"For many, especially retirees that are income-oriented—they were forced out of the risk spectrum and into other asset classes, including equities, in order to get that yield. Now they don't have to go out that risk spectrum. And that, again, knowing that people have gone through the pain of the total return losses, as we sit here now and look forward, I think there are opportunities. I think there are opportunities for a more active investing approach, both on the fixed income side and on the equity side of portfolios, and turmoil, volatility, and weak total returns do breed opportunity at some point. It's just that we have to get into that mindset."
Caleb: "Right, and just sticking to the benchmarks and just letting it ride on growth—if that was your strategy, it just doesn't work right now, and it's not going to work. So active is really important; advice is really important; the plan is really important. All right, we talked about pre-retirees and retirees. Again, for younger investors, this may be their first bear market. This may be the first time they've actually seen the economy weaken like this. What do you advise them? You know, there are some bargains out there, so to speak, but that doesn't necessarily mean you should buy everything that's on sale."
Liz Ann: "Right. You know, we often make generalizations, and I get asked for advice based on just age. And it's a component—ostensibly older, closer to or in retirement, lower risk tolerance, greater need for income, and vice versa on the younger end of the spectrum. But the reality is that just because you're young doesn't necessarily mean you're more tolerant of risk. You can be 25 years old, but if you experience your first bear market, and you go into panic mode when you see the impact it's having on your 401k or your IRA, and you bail—I don't care how young you are, you are not a risk-tolerant investor. So I think one of the things that a volatile period sometimes teaches us, or what a bear market teaches us, is whether there's a wide or narrow gap between our financial risk tolerance—the stuff that's on paper and part of our plan—and our emotional risk tolerance. So that's the first thing we have to do."
"But for younger investors who are going through this—the stock market's a weird market, in that it's the only market I know of that, when its products go on deep sale or a deep discount—we run away. Now, if your goal is to get in and get out, and make those decisions based on trying to time tops and bottoms in the market—it's a fool's errand. You will definitely be on the losing end of that proposition, because get in and get out, all or nothing—that's just gambling on moments in time. And investing, to your point, should always be a disciplined process over time. But bear markets do provide opportunity—things get cheaper, leadership changes. And along the way, we can take advantage of the discipline of rebalancing. Rebalancing is such a beautiful discipline because it forces us to add low, trim high—go against what fear and greed would tend to drive us to do."
"So I always see bear markets as an opportunity, without trying to precisely call tops and bottoms in markets—not just in the equity market, but all markets. They're processes. They're not moments in time. You have the rare March 23, 2020 bottom in the COVID-19 bear market—that truly was a V. But as you know, that's not what they normally look like. And, you know, at the recent low, the S&P was 25% cheaper, 25% lower than it was at the beginning of the year. And there's a way to take advantage of that, without feeling that you need to call the exact bottom or the exact top."
Caleb: "Which is why you say, and other strategists say it's the time in the market, not timing in the market, because none of us are going to get it right. You may get it right once, but you never know when to get back in or get out. Keep at it. And a great time to rebalance and dollar cost average. People say "don't look at your 401(k)—no, look at it! Make sure you know what your own—rebalance."
Liz Ann: "But panic is not a strategy."
Caleb: "Panic is not a strategy."
Liz Ann: "Nor is greed, by the way. Nor is greed."
Caleb: "Panic's not a strategy. Planning is a strategy, and you guys are so good about that. So what are the two or three things, or one important thing, that you're looking at, that you think is going to be very important right now, that's going to help you sort-of understand where things are headed right now? What are the indicators that Liz Ann looks at?"
Liz Ann: "So I think the sentiment environment, which, at extremes, tends to act as a contrarian indicator, all else equal, but typically needing a catalyst of some sort. Most sentiment indicators have recently gotten to what I would call sort-of the "washout phase." The only rub is that some of the behavioral measures: fund flows, household equity exposure haven't quite matched that same washout. At the June lows, at the mid-October lows, you had record low bullishness in measures like American Association of Individual Investors (AAII) survey. But you didn't see deep outflows out of equity funds, and you didn't see a massive spike in the put-to-call ratio. So I do think that maybe we didn't quite get to that 'puke phase.'"
"But that said, a lot of where the most speculative money had gone in the latter stages of the bull market did go through the puke phase—SPACs, the meme stocks, crypto, heavily shorted stocks—a lot of those narrative-driven trades. So when people say "don't we still need to get that complete washout?" And I say, well, we did in many of those areas, where drawdowns peak-to-trough were in the 70, 80, 90% range. So that may be a bit of a help, the underpinning. So in general, I think you can check the sentiment box as a decent positive. This most recent retest and move through below the June lows—the breadth under the surface actually improved. A fewer percentage of stocks were hitting new lows, even though the indexes were. That's called a positive divergence. That's what you tend to see toward the end of a bear market."
"From a macro perspective, what I think is still ahead of us, is I think we need to see stabilization in the dollar, stabilization in yields—they've been swinging wildly. I think we need stabilization in forward earnings estimates. I think those still have to come down more than they have, and then we need to see a stabilization in housing. Now, notice I said stabilization, not a bottom followed by a significant improvement. You know, the market operates off rate-of-change, when things stop getting worse and start getting better. So that's why I put the verbal emphasis on stabilization. And that, from a more macro perspective, is what I'm looking for—some of the indicators of, "okay, the worst is now probably mostly in the rearview mirror."
Caleb: "Those are great. And we're going to link to places where folks can find those so they can follow along. Well Liz Ann, we know you're a rocker. You love rock music. You always have a good song of the moment. What's your song right now for investors in this market environment? What's in your head?"
Liz Ann: "There's one that popped into my head in the summer, when this narrative around a pivot came about, and it was Aerosmith's Dream On. And there isn't a pivot coming anytime soon. So I'd say that one is still maybe appropriate."
Caleb: "That is so good and so classic, and I can just see Steven Tyler right now. All right. You know, we're a site built on our investing terms. That's how we were born. That was our foundation. What's the most important investing term right now that's on your mind, and that investors should be thinking about?"
Liz Ann: "You know, I touched on it already: "equal weighted." I think the average stock, instead of the small cohort of leadership names—I think we're in a leadership shift from the big-cap kind-of tech-oriented areas to the average stock. So equal weight—fundamentals matter again."
Caleb: "Yeah, fundamentals matter. Great term. We love that and we love your advice. Liz Ann Sonders, the Chief Investment Strategist at Charles Schwab. Thank you so much for rejoining The Express. It's always great to talk to you."
Liz Ann: "My pleasure. Thanks Caleb."
Term of the Week: Regressive Tax
It's terminology time. Time for us to get smart with the investing and finance term we need to know, this week. And this week's term comes to us from Raul in Lisbon. I just spent a few days there last week at Web Summit, and what an incredible conference and such a beautiful city. Raul suggests "regressive tax" this week, and we like that term given the madness around Powerball here in the United States. At last check, the Powerball payout was $1.9 billion. That's right, $1.9 billion. Your chances of winning are just one in 292,201,338. Lotteries, especially state lotteries, are often considered regressive taxes. Well, what does that even mean?
Well, according to my favorite website, a regressive tax is a type of tax that is assessed regardless of income, in which low and high-income earners pay the same dollar amount. The kind of tax is a bigger burden on low-income earners than high-income earners, for whom the same dollar amount equates to a much larger percentage of total income earned. A regressive tax differs from a progressive tax in which higher earners pay a higher percentage of income tax than lower earners.
So what does this have to do with the lottery and Powerball? Well, research has shown that poor people play the lotto more often, spend a higher percentage of their income on it, and are about 25% more likely to gamble for money, rather than for fun. One recent survey found that players making less than $10,000 annually spend $597 on average on lotto tickets every year, or about 6% of their income. So while no one is compelled to play the lottery or the Powerball, states spend hundreds of millions of dollars marketing the lottery to us every single year—a dollar in a dream. Since it costs everyone the same amount to bet on that dream, it is considered to be a regressive tax.
Good suggestion, Raul. I already gave you a pair of socks in person last week, and I'd like to see you sporting those on Pink Street in lovely Lisbon.