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Liz Ann Sonders: 2000-Style Market Sell-Off Not a High Risk

Charles Schwab's chief investment strategist discusses the rotation away from COVID-19 'thrivers' and the case for non-U.S. stocks.

The narrow ascent of a handful of stocks in 2020 has sparked comparisons with the year 2000, when the technology stocks that had paced the market cratered, dragging the S&P 500 and Nasdaq indexes down with them.

In a recent conversation on The Long View podcast, Charles Schwab's chief investment strategist Liz Ann Sonders discussed the likelihood of a repeat of that scenario. She also shared Schwab's research about how much of recent market leadership has been driven by what she calls "the big five"--Apple AAPL, Microsoft MSFT, AMZN, Facebook FB, and Alphabet GOOG--and the implications for the health of the broad market and the economy.

Sonders also delved into another topic of keen interest for many investors today: whether foreign stocks, which have dramatically underperformed U.S. stocks over the past decade, will have their day in the sun again.

The complete podcast recording and transcript also cover Sonders' outlook for the economy, her favorite economic indicators, and the role that monetary policy has played during the pandemic. The interview excerpt below was recorded on Dec. 15, 2020, and has been lightly edited for readability.

Jeff Ptak: Your team has looked at the difference in returns between the top five names in the S&P 500 and the other 495. And what you've observed is we're starting to see a market rotation away from what you've called the COVID "thrivers," that's the top five names in the index to the rest of the stock market. That's brought some relief, especially to those that were tilted a little bit more toward small- and mid-cap names. But isn't there a reason to question the durability of the rally if those big index names aren't leading the way, just given the sheer weight that they represent in the S&P 500?

Liz Ann Sonders: I think there is a risk to the extent that the relative weakness in the big-five names turns into something more severe or more protracted. For now, at least since Sept. 2, 2020--and I cited that particular day in my 2021 outlook and have cited it quite a bit recently as a key turning-point day--that was the initial move to all-time highs for both the S&P 500 and the Nasdaq. And on that same day, that was the peak weight that the big-five names represented in the S&P 500. So, to your point, they had hit almost 25% of the index, just those five names. Of course, the S&P is a cap-weighted index. So, that's why only five names--which are only 1% of the index, in equal-weighted terms--represented 25% of the index.

Sept. 2 was also the date when the spread between the performance of those big-five stocks and the other 495 stocks in the S&P 500 was its widest. And so, I track this on a rolling daily year-to-date basis and year to date through Sept. 2. The big-five stocks, by the way, are Apple, Microsoft, Amazon, Google [Alphabet], and Facebook. And the reason why I don't call them the big tech stocks is because only two of them, Apple and Microsoft, are in the S&P tech sector. Amazon is in the consumer discretionary sector. And Google and Facebook are in the communication-services sector. So, they actually span three different sectors; they’re often lumped together as tech stocks, but that's actually not the case. But those stocks, on average, as of Sept. 2 year-to-date were up 65%. The other 495 stocks were up only 3%.

An important component is whether the stock market is disconnected from the economy. And a metric I often cite, and certainly was citing back then, in what was still quite a beleaguered environment in the economy in early September, was that a market that is driven by a tiny handful of names versus the rest of the market is still in a fairly beleaguered state, too. At that same point, 36% of the S&P 500 stocks were still in bear markets, meaning down at least 20% from their 52-week highs. I think that is a bit reflective of what has gone on in the economy.

Now, fast-forward to today, what we've seen since Sept. 2 are a series of rotations, and they've had different flavors to them. Depending on what day or group of days or a week or a group of weeks you're looking at, you could define the rotations as being COVID winners to COVID losers or growth to value or large cap to small cap or defensives to cyclicals. You really could define it different ways depending on what actually was happening. But particularly in September and October, we saw two corrective phases. They weren't full corrections. But in the case of September, over three weeks, the S&P was down almost a full 10%, but those five stocks were down, I think, 16% or 17%.

So, back to the question of whether they represent a risk? Yes, that's the simple answer. But the more nuanced answer is that there is a benign scenario somewhat consistent with what we've seen since early September, where you ease some of this excess associated with that concentration, the narrowness, the market being driven by a very small handful of names through this process of rotation. As you see the market broaden out, as you see even the most beleaguered sectors like energy and financials do extraordinarily well in the last month and this post-Pfizer vaccine era, that has had the effect of bringing the weight of these five names now down to the low 20s. We still have a ways to go. But I think that could represent the more benign way that we ease some of this excess versus saying the only solution to this problem is circa 2000, you'll lose the leadership names, and it takes the entire market down with it. I don't think that's a prospect that represents a high risk at this point.

Christine Benz: You're expecting the international-stock market to wrest leadership from U.S. stocks. After so much time has elapsed, do you think conditions have lined up for foreign stocks to outperform? And what should investors do in response?

Sonders: We established that view in a somewhat general way as opposed to citing a particular country or group of countries whose stock markets we think are going to outperform the U.S. But a broader macro view based on several things: Number one, generally, when you exit one full cycle, and by full cycle, they tend to be cycles defined by both the economy and the market. So, you're in a bull market, you're in an economic expansion, you go into the combination of a bear market and a recession, which clearly, we have been in in this environment. And then, eventually, you move out of the bear market and the recession. Typically, you move out of the bear market first, then you move out of the recession subsequent to that, that's the natural order of things. And then, you start the new cycle.

Those major cycles, not the little mini cycles, but those major cycles tend to see a shift in a leadership. My colleague Jeff Kleintop, I believe, put this in his 2021 outlook, not exactly to the decade, but around decadelong cycles where you've got U.S. dominance at the expense of non-U.S. That cycle shifts and you get non-U.S. dominance over U.S., and we think we may be shifting into one of those cycles. It's not perfectly timed so that Dec. 31 will end U.S. outperformance and Jan. 1 will start non-U.S outperformance, but we may be in a cycle that at least means diversification outside of just U.S. equities is going to start to pay rewards.

We know there's a huge valuation differential between many non-U.S. areas, particularly developed international markets versus U.S. markets. In some cases, the underlying earnings trajectory is improved as well. Another benefit to some non-U.S. markets, we think, will be continued weakness in the U.S. dollar. And we just think we may be in the process of one of those shifts where you no longer want to shun non-U.S. investments based on the view that, as we hear all the time, "The U.S. is the only game in town." That's really the message we wanted to impart, as we look ahead to this next cycle, that the dominance of the U.S. is probably a thing of the recent past.

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