Fri, 24 Feb 2012
With equity valuations still relatively attractive, investors should shift their attention toward the more cyclical areas of the market to play a second-stage recovery, says Schwab chief investment strategist Liz Ann Sonders.
Christine Benz: Hi, I'm Christine Benz for Morningstar. I'm here at the Morningstar Ibbotson Conference, and I had the opportunity to chat with Liz Ann Sonders. Liz Ann is chief investment strategist for Charles Schwab. She shared her outlook for the economy as well as for the market.
Christine Benz: Liz Ann, thank you so much for being here.
Liz Ann Sonders: Thanks for having me.
Benz: You recently wrote a piece where you talked about investors who have been kind of sitting on the sidelines. We are now three years into this rally. The question I think naturally crossing investors' minds is, "Is it too late to buy stocks?" What's your take on that question?
Sonders: I don't think so. You have to look at the market, obviously, in terms of valuation. So, yes, we've had about 100% rally over the last three years, which is a big percentage increase.
First of all, that's not excessive in terms of normal bull markets, either in length or strength. So, that piece of it does not rally anything significant historically. Then valuation, you're still looking at P/E on next 12 months earnings of only about 13 times, versus a long-term norm of 17. So, what that highlights is even though the market has doubled in the last three years, earnings growth has been even greater than that. So, valuation has actually stayed quite reasonable, and I think the market still looks good here.
Benz: Okay. So, within the market, which you think is pretty attractively valued overall, are there any pockets that you think are especially promising right now?
Sonders: Being relatively optimistic on the economy--that does not suggest a boom is ahead of us--but probably more optimistic than the consensus, we think investors should shift their attention towards the more cyclical areas of the market. The two sectors on which we have "outperform" ratings right now are technology and industrials. So, clearly, cyclical pays.
I think any of the money that went into equities in the last couple of years--you probably could argue begrudgingly had gone into equities--went into the more defensive area--so last year, the classic dividend plays, the utilities, and the consumer staples. So, I think it represented still this fear about anything cyclical and, I think, mistrust of the recovery until recently. Now, I think you want to play what I think is a second-stage recovery, and that will come in the more cyclical areas.
Benz: One mantra that I think we've been hearing for several years running is quality looks cheap, dividend payers are where you want to be. Would that be your take?
Sonders: Well, again, I think some of the classic dividend payers in the ... highly defensive areas, like utilities as a perfect example, the best-performing sector last year, I think those maybe have gotten a little bit overdone. So, I think investors' first instinct was, I want to pick up some yield, but I want to go into the safest companies. Now, I would look for more cyclically oriented companies that may also be dividend payers, but also look for companies that have the potential to increase dividend. That, I think, is probably the next big play within equities, even for those people who are looking for yield as they move some money from fixed income.
Benz: Now, one area you haven't touched on is financials. Dividends are there, maybe the cyclicality is there. What's your take on this sector?
Sonders: It has been tempting to upgrade financials. We have it as a "market perform." So, we're past the stage of being negative on the financials. There have been moments in our strategy group where we've talked about, "Boy, is this the time?" but we just haven't gotten the guts yet to do it. So, I still think the issues are not fully resolved. We've had a pretty decent decline in the willingness to lend on the part of banks, as they've been dealing with the effects on U.S. banks of the European crisis. I think some of that is easing right now, but we think it's maybe a little bit early to step up to the plate with an "outperform" rating. But you probably don't want to be too underexposed to financials, because they have proven to be pretty powerful movers in some of the recent rally phases in the market.
Benz: You touched on the European crisis, and I'm wondering if you can share your global outlook for investors who are allocating U.S. versus international, also emerging markets. What's your take on that question?
Sonders: The European crisis is not solved. I think what the European Central Bank did with their long-term refinancing operation, the LTRO, was to really ease what had been an acute ... potential liquidity crisis, and fear of another Lehman-type moment. I think that's largely been taken off the table. It doesn't solve the solvency problem, that are places like Greece. So, we'll still have to deal with that, but that real acute phase, I think, has gone.
It's one of the reasons why confidence is kicking back in, and we're actually seeing things like Purchasing Managers' Indices, a measure of economic growth, even in the eurozone pick up. So, we have this global turn in the economy, that I think is a surprise to many people who thought there was no hope for that late last year.
We also have easy monetary policy across central banks globally that is nearly unprecedented, and that really has turned what had been a pretty significant headwind last year--because we had central banks globally tightening policy to combat inflation--now, we're easing policy, and I think that is a big push globally for markets.
Now that said, I still think the U.S. market in relative terms will probably be the best performer as much as it was last year--and I'm talking about the equity market. Second to that would probably be the emerging markets, because they now have this tailwind of easier monetary policy, and then the non-U.S. developed markets would probably bring up the rear in terms of relative performance.
Benz: OK. Last question for you Liz Ann. The stamped we've seen into fixed income, I'm wondering if you can address that. My fear is that some investors might be driving with the rearview mirror. What's your take on that?
Sonders: I think it depends on the investor. I think there's probably a pretty decent percentage of the money that's got into fixed income that is there long-term. It's what I would call sticky money. It's there because of where they are in their life stage, demographics, and all of those things. So, that would be one bucket.
Then there is another bucket I think of pure momentum chasers, because that's where the returns have been. Long bonds were the best-performing asset class last year. That's probably less sticky money.
Then, the third general group might be people who have gone in with money that is really their cash money. So, it's a proxy for cash. When in a money market, a traditional money market, you're getting a fractional yield, they still want that perceived safety, they're just moving it out the maturity spectrum. So, that's also probably less sticky money, particularly if equities continue to do well, and you start to see yields pick up a little bit, and some of this money now has the risk of actually a loss, because of the price depreciation component that was not a factor.
So, I think some of it is sticky money, some of it probably could find its way back into equities a little bit more quickly than a lot of people think.
Benz: OK. Well, thank you, Liz Ann, for sharing your views.
Sonders: Thanks for having me.