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Liz Ann Sonders: 'We Could See Some Inflation Scares'

Schwab's chief investment strategist discusses the impact of the pandemic in 2020 and what the new year will bring for the market and the economy.

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Our guest on the podcast is Liz Ann Sonders, who is senior vice president and chief investment strategist at Charles Schwab. In her role, Sonders is responsible for conducting market and economic analysis, which she and her team publish in a variety of forms. She also regularly appears in the financial media and was recently named to Barron's "100 Most Influential Women in Finance" list. Sonders joined Schwab in 2000, when the firm acquired her prior employer, U.S. Trust. Before that, she was a managing director and senior portfolio manager at Avatar Associates. Sonders received her bachelor's degree from the University of Delaware and her Master of Business Administration from Fordham University's Gabelli School of Business.

Background Liz Ann Sonders' bio

Market Outlook "Schwab Market Perspective: Watching the Wheels," by Liz Ann Sonders, Jeffrey Kleintop, and Kathy Jones, Charles Schwab, Dec. 11, 2020.

"2021 U.S. Market Outlook: Better Days?" by Liz Ann Sonders, Charles Schwab, Nov. 30, 2020.

"2020 Mid-Year Outlook: U.S. Stocks and Economy," by Liz Ann Sonders, Charles Schwab, June 15, 2020.

"2020 U.S. Market Outlook: Ramble On? by Liz Ann Sonders, Charles Schwab.

"Another Tricky Day," by Liz Ann Sonders,, Aug. 11, 2020.

"What Is Don't Fight the Fed?" by Kent Thune, The Balance, July 15, 2020.

"Fed Aims to Help Nurse the Economy Back to Health," by Liz Ann Sonders,, April 30, 2020.

"The Song Remains the Same: Fed Keeps Rates/Balance Sheet Steady," by Liz Ann Sonders, Charles Schwab, Dec. 16, 2020.

The Pandemic and the Future "How the U.S. Economic Stimulus Package May Affect Investors," by Schwab Center for Financial Research, March 27, 2020.

"Schwab's Liz Ann Sonders Puts Odds of Stimulus at Slim to None," by Jeff Benjamin, InvestmentNews, Oct. 28, 2020.

"Triage: Throwing Everything at the Virus," by Liz Ann Sonders,, March 24, 2020.

"Schwab's Sonders, Kleintop Predict Weak Start for Economy in 2021," by Jeff Berman, ThinkAdvisor, Dec. 20, 2020.

Transcript Jeff Ptak: Hi, and welcome to The Long View. I'm Jeff Ptak, global director of manager research for Morningstar Research Services.

Christine Benz: And I'm Christine Benz, director of personal finance for Morningstar.

Ptak: Our guest today is Liz Ann Sonders. Liz Ann is senior vice president and chief investment strategist at Charles Schwab. In her role, Liz Ann is responsible for conducting market and economic analysis, which she and her team publish in a variety of forms. She also regularly appears in the financial media and was recently named to Barron's magazine's "100 Most Influential Women in Finance" list. Liz Ann joined Schwab in 2000, when the firm acquired her prior employer U.S. Trust. Before that, she was a managing director and senior portfolio manager at Avatar Associates. Liz Ann received her bachelor's from the University of Delaware and her MBA from Fordham University's Gabelli School of Business.

Liz Ann, welcome to The Long View.

Liz Ann Sonders: Well, thank you for having me. Really appreciate it. Looking forward to our conversation.

Ptak: So, let's start by seeing macro through maybe an individual investor or financial advisor's eyes. They are staring at a sea of different measures and indicators, some forward-looking, others backward-looking, and sometimes they can contradict each other, as we well know. So, if you are an individual investor and advisor trying to make sense of all this, where would you start?

Sonders: So, it's a great way to frame the question in the context of how we look at economic data, and then translate that into maybe what the message is from markets and conflicting data. And I think even in a pre-COVID environment, which basically means in any environment, one of the most important things I think investors need to do, advisors need to do, anyone that's analyzing economic data and trying to put it into context, is to understand the difference between and relationship of leading coincident and lagging economic indicators, especially when we're trying to connect economic stats to the stock market.

And because there are a few really, for lack of a better word, popular economic data points, like the unemployment rate, those are economic data points that we think of as very reflective of what's going on in the economy. Most people, if you did a man on the street/woman on the street interview, would have a sense of that. It's not a more arcane statistic like building permits. It's something that's in the mind of most Main Street people, investors, individuals. Yet, the connection that people try to make between the unemployment rate and either what's going on in the economy at that moment, or in particular, what's going on in the stock market, gets lost by virtue of the fact that the unemployment rate is one of the most lagging of all economic indicators. So, really understanding what are the leading indicators--meaning they're the heads-up indicators, they move first, and the stock market, of course, is one of those leading indicators--how that works in conjunction with the coincident indicators that those that move at the same time as things like GDP and then again, the lagging indicators.

But I think in this COVID world, what's equally important is to add into the leading indicator mix some of these kind of newer, higher-frequency, more COVID-relevant leading indicators, economic data metrics, and there's some interesting ones, everything from the kind of mobility data that Google GOOG puts out or Apple AAPL puts out to measure whether we're actually getting out and about--we're getting in our cars, we're going places, box office receipts, open-table seated diners, TSA-traveler throughput. So, there are so many ways we are able to analyze data right now that we can tie in with a lot of specificity into typical leading indicators to get an in-the-moment sense of whether we're getting some traction in the economy, particularly parts of the economy that have been in the most beleaguered a state since the pandemic erupted.

Benz: What has experience taught you are the most underrated forward-looking measures or leading indicators of the economy's likely future direction, and what are the most overrated? And maybe you can separate that into some of these newer metrics that you're looking at, some of the ones that you are most impressed by in terms of their predictive ability, and then some of the evergreen leading indicators?

Sonders: So, I think the leading indicators that tend to be most telling in terms of ultimately what's going to happen in the economy are tied to the labor market. Of course, initial unemployment claims are embedded in most indexes of leading indicators, but tied to that, especially in an environment like this, a more severe recession, a more protracted downturn, you've also got to look at things like continuing claims. I think that the relationship between temporary job losses and permanent layoffs, especially in a severe economic contraction, like we're in right now, takes on a greater amount of importance.

Also, within the labor market, I think the duration of unemployment is a real factor that is forward-looking in the sense that the longer individuals stay unemployed two things tend to happen: the greater the likelihood is that they simply drop out of the labor force. And at least based on history, there tends to be more of a stigma attached to people who have been unemployed for an extended period of time, which, in turn means less likely to find a job, more likely to drop out of the labor force. Now, that stigma may be lessened in this environment because of just the nature of COVID. And I think that stigma will be alleviated, maybe not completely by virtue of the fact that there are parts of the economy, certainly in the services, travel, and leisure area, that for all intents and purposes have been in some semblance of shutdown mode. So, I don't think that stigma will be as applicable this time.

But what things like rising permanent unemployment and long-term unemployment show is the scarring of an economic recession, of a crisis, or a combination of the two of those on the economy. And not in your garden-variety recession but in a crisis-driven recessionary period, I think those scarring effects need to be put front and center when looking ahead. So, I think those are the most relevant data points.

The ones that are less relevant, I think, is just the individuals who simply just try to connect what's going on in the economy. And each individual that might ask a question about the perceived disconnect between what's going on in the economy, what's going on in the stock market might have myriad indicators that they might cite as an example. But I think the worst thing investors can do is at a moment in time look at the economic data individually or as a grouping and then compare it to what the stock market is doing without understanding the leading, lagging, forward-looking nature of the stock market and also, most importantly, understanding that when it comes to economic data, the stock market tends to care more about better or worse than it does good or bad. So, that's another thing we tend to do. We tend to think of economic data as individuals in black or white terms or good or bad, strong or weak. But it's that more subtle rate of change, better or worse, that tends to be the kicker from a stock market perspective.

So, I think if you're trying to as an investor think about the nature of the economy, we have to at least think as much about the rate of change, the better-or-worse force than we do the good-or-bad force. And that's why investors so often will miss major inflection points in the market. Think about March of '09. The economic data was still horrific, and many of the data points were getting worse, not better. But we know with the benefit of hindsight that that was a launch point for the stock market because of its forward-looking tendencies, its ability to pick up on that at times subtle shift in direction of the economic data.

Ptak: I wanted to reference something you recently wrote, which is "the stock market has a remarkable ability to look across chasms of economic contraction to the other side." So, my question is, how has more aggressive monetary policy changed the way you and your team look at the relationship between the economic cycle and the market cycle?

Sonders: It has always been important monetary policy. I started in this business in 1986, working for the late, great Marty Zweig who was just an icon in our business in the '70s, '80s, and '90s. And he started one of the first-ever hedge funds. He invented the put/call ratio, but a lot of people don't realize he also coined the phrase "Don't fight the Fed." And one of his seminal works was a best-selling book called Winning on Wall Street. And there was a whole section devoted to monetary policy tied to his mantra of "Don't fight the Fed" and the implications it had for the equity market for asset markets more broadly.

I think we really saw the power of monetary policy initially coming out of the global financial crisis with the Fed's first-ever move to pinning the Fed funds’ rate at zero and staying there for an extended period of time, launching what, during that era, were three rounds of quantitative easing. And then, of course, fast-forward to the COVID era, not only bringing back out those tools from the financial crisis era of 0% interest-rate policy, effectively promising that rates would stay at zero for as far as the eye can see, relaunching QE forever, as it's been called, but also establishing some of the brand-new facilities, backstop lending facilities. And what a lot of people don't realize is, some of the announcements, the key announcements of some of those relatively new facilities that they were putting in place specifically for this crisis was on March 23, which was to the day the low in the stock market. And that was not coincidental. That just shows, not just the power of the Fed's policies, but increasingly and more recently, the power of the Fed's words, the power of the Fed's promises to, we've got the tools, we are going to pull out all the stops. Even in that case, these facilities were announced they weren't even operational yet, just simply the Fed saying, we've got basically the financial systems back.

I think the peril, though, of what the Fed has done to some degree is it's instilled this notion that the Fed will always have the back of the stock market. And this was pre-COVID. But I attended a lunch at The Economic Club of New York, at which Trump spoke and there was most of the attention was on what became his reversal to what he had said in September of 2018, where he then became a bit more dovish. But I thought the key thing that he said during this particular lunch was that it's important for investors and financial markets to distinguish between financial-market volatility and financial-system stability, that just because the stock market might go into a period of high volatility or corrective phase, if, as part of that there isn't a threat to financial-system stability, don't expect the Fed just to come in and be the backstop for any downside in equity markets. Now, what happened in March, of course, is what they were doing with 0% interest rates, quantitative easing again, and the announcement of these new facilities was trying to prevent what had started as a health crisis, became an economic crisis from becoming a financial-system crisis.

Now, I get the question all the time, but explain to me how what the Fed has done either through their words, their announced facilities, 0% interest rate, directly is a feeder through the plumbing system into the benefit of equity markets? That's not really the case that what the Fed is doing directly adds to buying an equity. They're not adding equities to their balance sheet. But it's the whole narrative of the Fed pumping liquidity into the system, pumping confidence into the system, and especially in an environment back in March and April, where the economy was shut down, you pump all this money into the system, into the financial system, into the credit markets, and then through the fiscal side--which I know is not really the question--into the hands of businesses and individuals in an environment where the economy was shut down. Well, that liquidity has to find a home and it found it and typically finds it in not just equities, but in asset markets. So, I get the question all the time: What about inflation? Why haven’t we had inflation in light of all of this massive stimulus? And the answer is, well, we've had plenty of it, it's just been in asset prices, not in the real economy. So, it is, monetary policy has always been and is increasingly a powerful force providing a lift to equities. I just think there's too much complacency that the Fed always has the back of the stock market, especially if it's a market issue and not a financial-system issue.

Benz: What has surprised you most during the pandemic?

Sonders: I'm going to answer this at least initially with a lot of optimism because there's so much pessimism these days. Human ingenuity I think is extraordinary. The fact that now the new cycle is about vaccines and Americans getting their first shots and the fact that we are talking about a vaccine in distribution right now less than a year after we knew anything about COVID-19 is extraordinary, given the shortest span of time prior to that was four years. So, I'm unbelievably impressed with the scientists, with the medical community, not just in the creation of the vaccine, but very quickly learning about this virus and treatments and therapeutics. There's been so much focus on the vaccine, but we have to be as mindful of the attended benefit of knowledge plus therapeutics and treatments. And that is just remarkable to me.

For the most part, the resilience on the part of individuals in terms of heeding the advice of the scientist and social distancing and mask-wearing and sacrificing everything from family gatherings to the touch and feel of in-person and adapting and companies being able to adapt to a very different world. Now, it's uneven, there's no question about it. And what I think we're seeing very starkly in this environment is what many, including me, are talking about in the context of this sort of K shape, where it really has exposed such a wide chasm between the winners, the losers, the haves, the have-nots, and it's not just specific to COVID. And we know that's the case in terms of people with preexisting conditions, on the weight scale, on the demographic scale, we know it as it ties to the economy, higher-income people being more able to work from home versus lower income, the strength in goods versus the continued weakness in services. The list goes on and on. So, that has been unbelievably stark. And parts of the economy that are suffering the most are typically the parts of the economy in a normal recession that are the most resilient. So, we're also rethinking the nature of what is defensive, what are the safe-haven assets, and in many cases, they are very different than what we're represented as defensive or safe-haven assets during traditional and past recessions.

Ptak: I think you've referenced one example is long-term unemployment. But I wonder maybe we can back up and generalize a bit. You can give us a damage report of sorts on the U.S. economy, maybe looking at it as a two-by-two grid, one axis being the severity of damage and the other being how long-lasting the effects will be. For instance, what are the things that have been badly damaged amid the pandemic and will take a long time to fix?

Sonders: I think it is in the parts of the economy that have historically been a bit more resilient. So, broadly, services; maybe more specifically, a lot of the travel and leisure area--I think maybe not permanent damage, but longer lasting than just tied to whatever we foresee as the key vaccine date, whether it's once we're at a point where distribution is sufficient that most people who can get one have access to getting one. There are still a lot of secondary things to think about, not least being other strains of the virus or side effects, other logistical distribution problems that could crop up between now and that point, just the takeup, other viruses having nothing to do with COVID cropping up. I think that there will be a greater amount of caution tied to getting out and about in closed circles, and especially for folks on the older end of the spectrum. And it's not just a function of the fear associated with COVID, but how we have adapted to a very different world.

And you think about the recent announcement by some of the major movie production companies that they're going to, at least in the near term, bypass the movie theaters and go right to the online streaming services; how the music industry is adapting to virtual concerts that arguably open up the opportunity to see artists to many, many more people that don't physically have to be in the stadium at that point in time. So, I think that there are longer-term implications of this that are not just driven by the persistence of virus-specific fear, but just a forced change in the way we conduct business, how we've adapted to video technology, digital technology. I always use my parents as an example: My mom is almost 83, my dad is 90. And they were not digitally oriented people. They were not video-oriented people. They did all their banking in the very traditional way--local branch, get in the car, drive there, deposit a check, take money out from the teller--and they do everything online. They wouldn't have done it before, but they were forced to, and they'll never go back. We do family Zoom calls all the time. That would not have been something that we have done in the past. Doing this right now--I mean, this is a podcast, so it's typically audio. But I've done I think 90 client events virtually since everything shut down, reaching tens of thousands of clients. It doesn't exactly match the in-person, but when you have that greater reach and there's a greater comfort level on the part of individuals having been "forced" to adapt to some of these changes, I think many of those changes will be long lasting, not least being a more flexible way to think about how and where we work, and not just the physical location, but understanding the differences in individuals and there's morning people and there's evening people. And the knowledge on the part of corporations now that an integration of every aspect of your life can occur with not only not a dent to productivity and efficiency, but to some degree a boost to those things, especially for people who might be eliminating three hours of commuting, which was on the days where I would have to go into Manhattan from my Connecticut home--and we don't live in Connecticut anymore--that was three hours of my day, that was not pleasant. And that just disappeared. And I think there are long-term implications of this virus not driven by the virus itself but by the change in how we've had to adapt to the virus.

Benz: In your view, what are the most important fiscal priorities to advance in the next round of stimulus, starting with the absolute must-haves?

Sonders: I don't know that there's an absolute must-have except get it done. I think that we know we need fiscal relief. It has to be targeted toward the parts of the economy that are in most desperate need of it. So, clearly, those small businesses that are still trying to hang on, the individuals who are potentially still out of work and need that added assistance. I really think, again, going back to where we started--this massive chasm created, and what we've tried to do is, and I had a visual associated with this cartoon, so to speak, in my 2021 outlook, that is a bridge over this chasm, and about the only plank that spans the full length of the chasm has been on the monetary stimulus side, the monetary liquidity side, and that allowed for the bull--the market--to get fully to the other side.

But from a vaccine perspective, obviously, we're getting there, and time is the only factor. But on the fiscal side, all we can do is look back at the importance and power of that. At the time, it was initially received during the worst part of the pandemic and the support that it provided to the consumption side of the economy, to businesses being able to hang on, and we're back at it again, and something needs to be done. And I think there's too much "arguing" about the details within, and I don't want to say just throw anything in there, we just need something. But we need a reasonably sized fiscal relief package, again, that's targeted in areas that are most beleaguered right now. And I am in full agreement every time Jerome Powell, and I'm assuming he's going to do it in conjunction with the FOMC meeting this month, during the press conference, this really pressed the idea that it's really on the fiscal side, where the relief will be most targeted and most effective, that monetary authorities have effectively done as much as they can and where we still have those gaps in the economy can be best done on the fiscal side.

I do agree with both the left and right on some of the sticking issues. I think more aid does need to go to state and local governments. That's where the job losses have been most severe and will continue to be. I do believe in the need for some liability protection, so when we come out of this, we're not looking at small businesses facing lawsuits. So, I agree on both sides with some of the sticking points. But I still hope that however those are negotiated that we end up with a reasonable-sized package that just, even if not perfect, helps continue to get that plank fully to the other side.

Ptak: We're going to talk in a few moments about some of the specific aspects of your recently published 2021 outlook. But before we did that, your 2020 outlook likely got upended like every other outlook by the pandemic. Did that experience change the way you put together your 2021 outlook?

Sonders: Well I think anybody doing annual outlooks when you go through an experience like this, clearly the focus to a great degree on the 2021 outlook was the virus and how we continue to pull ourselves out of this. That said, my 2020 outlook and subsequent reports, particularly one that I wrote at the very end of January, so it was probably two reports after the publishing of the 2020 outlook, cited as a key risk the sentiment environment that had gotten a bit frothy. And I often think that that can represent a significant risk for the market. It also, in the opposite direction, when sentiment gets incredibly despairing, it can represent a huge opportunity for the market even without any significant change in the fundamentals.

So, I had cited in the 2020 outlook, and again, focused more in more detail by the end of January, early February of this year on sentiment that was getting frothy. In fact, I wrote a report at the end of January of this year, that I titled "Virus," and it posited that when sentiment gets extremely optimistic that in and of itself that doesn't suggest the market is going to move in a contrarian fashion but it establishes greater vulnerability to the extent there's a negative catalyst. Well, we got the mother of all negative catalysts, of course, in February with COVID. And I had to in 2021 outlook fully address the virus, but I found myself also again expressing concern about the risk associated with frothy sentiment. So, that was a common thread at the end of last year and the end of this year, which had really very little to do with the virus itself, other than the fact that I think the recent surge in some of these sentiment measures showing more pervasive froth or speculation than what we were seeing in a more concentrated way back in the September time frame. That simply was driven by the success of the market breeds the risk of overexuberance. And again, it's a terrible pool sentiment if you're going to use that solely to try to time moves up or down in the market. But as an exogamous factor, it needs to be wrapped in when you're looking at where the risks and opportunities are from a market perspective. So, it was interesting that in two very different years there was still that similar sentiment thread back at the end of 2019 and again at the end of 2020.

Benz: Based on your 2021 outlook, it sounds like you're expecting economic growth to slow for a time in 2021. What makes you confident the U.S. economy won't slip into a recession altogether, especially with various forms of fiscal relief slated to roll off?

Sonders: Well, quite frankly, at least based on the formality of the National Bureau of Economic Research, the NBER, which formally declares and dates recessions, we're not out of one. So, it's hard to answer that in the sense of will we go into another recession? It's just a question of when do we come out of the existing recession?

Now, what's unique about this cycle is not so much the speed with which the NBER came out and not just declared that we were in a recession, that was sort of obvious, but very quickly pinpointed the start point. That is not terribly abnormal, because what a lot of people don't realize is the NBER waits for a while before they feel that they've got concrete enough evidence to suggest, OK, we're in a recession right now. Then the next task is to say, when did it start? That's not a terribly difficult task, because what they do is they go back, and they look to the peak in the economic data points that drive that decision-making. So, there's a business cycle dating committee, part of the NBER. They basically go back to the peak. The four key metrics that the NBER measures--and it doesn't so much vary, but they look at myriad metrics--but the key ones that are embedded in the actual definition of what a recession is put out by the NBER are not coincidentally the four sub-components of the Index of Coincident Indicators, so it's payrolls, it's industrial production, it's wages, basically average hourly earnings and retail sales, basically, wholesale and retail sales.

They go back to their measure of the aggregate in the data, which is another reason for what we talked about earlier, this misunderstanding sometimes that investors have of when you hit an inflection point. Because back in the February time frame, leaving aside COVID, the economic data was actually fairly robust. But we only know with the benefit of hindsight that that was the peak in activity. But that's when the NBER goes back. What they also do then, conversely, is once they decide, OK, we're out of a recession, they go back to the trough in data. And that's why there are assumptions out there by economists that if and when the NBER dates the COVID recession as having ended quickly, they would go back maybe to the April-May time frame.

I think part of the reason why the NBER is being a bit more hesitant--and they're always hesitant, they always date beginnings and ends of recessions well after the fact--is that in this case, as much as I've talked about rate of change being important, that better or worse matters more than good or bad. The severity of the compression in the economy, the decline in GDP to a degree unlike anything we've seen since the 1930s, the massive loss of jobs, the fact that, even though they've improved, initial unemployment claims are still running more on a weekly basis than the worst week ever in the history of the data. They may be hesitant to come out and say the recession ended in April or May, not because they want to avoid the early '80s-style double-dip recession, but the body there that dates recessions maybe saying, we have to be mindful of level here. GDP has only clawed back about two thirds of the way, pre-pandemic; payrolls have only clawed back two thirds of the way. We're still in a massive hole relative to history.

So, I think we're in the process of another dip down in the economy. It'd probably be less seen in the fourth quarter, because we had a lot of momentum coming into the quarter. So, there are economists for the most part that are upping fourth-quarter estimates for GDP, and the range is really wide. But most of those that have upped fourth-quarter estimates have lowered first-quarter estimates and, in some cases into the second quarter, too, to try to reflect the more precise timing of the virus-hit to economic activity, especially given that some of the shutdowns and lockdowns are occurring now-ish, which is, almost at the end of the quarter. So, I think we're effectively guaranteed that we're going to see another dip in economic activity. We're already seeing it across the spectrum of economic data points, particularly the real-time higher-frequency data points that we talked about. Whether ultimately it goes down in the history books as one long recession or a double-dip recession is yet to be seen by virtue of the arbiters of recessions having yet to give us that official information.

Ptak: We've talked about it earlier in the conversation, but there's been a sharp rise in permanent job losses and long-term unemployment has also spiked. It sounds like you're optimistic that some industries like online retailing and residential-housing construction will reabsorb at least a portion of them. But will they be able to maintain their pre-pandemic standard of living?

Sonders: So, longer term, I'm actually fairly optimistic on that front. So, if we think longer term at maybe where employment opportunities will be more robust looking ahead versus where employment was most robust in the latter part of the last cycle, from a compensation perspective, I think the outlook is fairly bright. I'm a believer that as we look ahead to the post-pandemic cycle, I think we're going to see a shift away from consumption and services being such dominant drivers of our economy and more toward an investment-driven economy. That doesn't mean that consumer spending, which at the recent peak was almost 70% of GDP, is now going to give way to investment that's 70% of GDP. But that we're just going to, and already seeing, a bit of a subtle shift as I think consumers are spending differently, spending less. They are not spending like two cycles ago off the back of higher debt. They're not doing mortgage refi and taking out loans in order to fund discretionary consumption. I think savings rates will stay a bit higher. Leverage will stay a bit lower in general, and we're already seeing a significant pickup on the investment side of the economy. For the most part, it's in residential real estate and construction. Those are big job opportunities.

And, in fact, when we had the housing boom two cycles ago, that burst in the '05-'06 period of time, a lot of workers from that industry that had now had its bubble burst, ended up moving into the leisure hospitality services area. And I think we'll start to see a shift of some of those people back into industries they were in before if you're not talking about somebody on the much younger end of the spectrum. But I also think we may see continued boost in terms of a driver of our economy outside of just housing, but healthcare investments. I think healthcare is going to be a broad sort of booming sector. I don't mean that from a stock market perspective. No one should infer that I'm just saying go out and buy a healthcare ETF. I'm talking about how it's embedded in our economy and where focus and investment is going to be. We're certainly seeing the needs for that through COVID. I think we're going to see it in infrastructure, whether it's partly driven by bipartisan support for something on the government end, some sort of public-private partnership. I think we've exposed the need for everything related to transportation investments, especially as we've seen our economy shift from bricks-and-mortar retail to online and what that means in terms of logistics and transportation. I think we'll see it in education. Again, COVID exposing the need to rethink about education, how it's transmitted, how we improve it, how we grow it into the 21st century.

So, I think when I think about the drivers of growth longer term, and then look at what some are calling the dinosaurs of prior cycles, the drivers are more important from a labor market perspective. They employ more people than the more beleaguered areas in the economy that have the possibility of staying in that somewhat beleaguered state. That doesn't mean you see things turn on a dime. We're in a process of massive creative destruction right now, to cite Joseph Schumpeter. And we're in the midst of the destruction part, even though we're seeing some of the creative part of it. And interestingly, the small-business survey, the NFIB small-business survey, the number one problem they cite right now is back to being skills gap, the inability to find workers. So, that's another reason for a focus on investment in education and training and narrowing the skills gap. And it eventually, I think affords lots of opportunities for some of the more displaced workers. But it's an ocean liner turning; it's not a speedboat turning. This is not an immediate elixir for what ails the Labor Department. But it's a longer-term reason for optimism.

Benz: Your outlook doesn't seem to consider inflation and acute worry. Your rationale is that while money supply has greatly expanded, the transmission of money hasn't. Can you elaborate on that? I think you hinted at it a little bit before with respect to asset-price inflation.

Sonders: Sure. So, I think that there are several transmission mechanisms for inflation to erupt. Assuming we're talking about inflation in a fairly traditional sense, and we're not talking about asset inflation, which we already addressed and/or we're not talking about specific price increases driven by short-term supply/demand imbalances. So, the fact that last spring, and to some degree now again, we'd all be willing to pay exorbitant prices for a large pack of toilet paper is not the kind of inflation I think we're generally talking about when people ask the question. So, there's several factors that I think at least in the near term, keep inflation in check, even if we are going to experience price increases in certain categories, within certain services of certain goods, because of the supply/demand imbalance. So, it's important to distinguish between the two.

We have seen a massive surge of money supply driven by both what the Fed has done and what fiscal authorities have done to the tune of 25% annualized growth rate in money supply. Whereas M2 growth rate is up about 25%, M2 velocity, which is basically the ratio that measures whether all that liquidity money that has been pumped into the system--the economic system, the financial system--is coming out into the economy and picking up velocity. So, it's coming out through the lending channels, through the consumption channels. It's being spent, it's being used to invest, to build. That velocity has continued to be incredibly low and it's been really coming down for the most part for three decades. This is not a new phenomenon. It helps to explain why coming out of the financial crisis with massive QE and interest rates at zero, we didn't see a surge in inflation because there was very little money velocity. So that's one factor.

Also, the labor market comes into play. And you typically don't see a big inflation problem until you're at or closer to full employment and you start to see that upward move in wages that can kick in the so-called wage/price spiral. So, even if we started to see some of the supply/demand imbalances and even a pickup in velocity as the economy starts to more fully open up, I would expect any real inflation, systemic kind of inflation problems, not to be a concern until we see the unemployment rate down to something closer to full employment, maybe call it sub-4%. In the meantime, this crisis, leaving aside the toilet paper example, is more of a disinflationary, or deflationary, crisis than an inflationary one.

So, I think there may be some inflation scares on the horizon in 2021. The biggest component of CPI--which is not the Fed's preferred measure, but it's the more common measurement of inflation that I think the average person is aware of--a heavy component of that is something called owner's equivalent rent, which looks at not just rental costs, but also implied costs of housing for even people that own homes. And, of course, we had a huge compression in that. We had the eviction moratoriums, and particularly in urban areas that are still quite beleaguered, like San Francisco, New York, we've seen a huge move down in average rental prices.

Well, as we move into 2021 and the economy starts to open back up and we start to see a pickup, we're going to see the comparisons, the year-over-year comparisons on a metric, like owner's equivalent rent, start to represent pretty lofty percentage increase numbers, which will find their way into CPI. Now, although most inflation measures are looked at in a core sense--so excluding the more volatile food and energy components--headline inflation is also set to continue to rise because we're seeing food inflation, some of it driven by supply/demand imbalances, but we're also seeing energy inflation, oil price inflation, driven by stronger global growth, getting to the point post-vaccine where we're seeing the economy pick up. So, we could see some inflation scares, actually some typical inflation indexes moving up, but the kind of '70s, '80s, early '80s-style systemic inflation that causes the Fed to have to get really aggressive and interest rates to go through the roof, I don't think that that is a high risk at this point.

Ptak: In the time we have left I wanted to ask a few questions about your equity market outlook. Your team has done some good work looking at the difference in returns between the top five names in the S&P 500 index 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. And so, that's brought some relief, especially 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 Index?

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, and I cited that particular day in my 2021 outlook and have cited it quite a bit recently as a key turning-point day. And so, what happened on that particular day was 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 is only 1% of the index; in equal-weighted terms, 500 stocks, 5 names, but representing 25% of the index. That was also the date, at which point 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, which by the way, for those that don't know, are Apple, Microsoft, Amazon, Google, 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%.

By the way, a bit of an aside, but an important component to the answer to the question about is the stock market disconnected from the economy? And often a metric I cite, and certainly was citing back then, that the reality during what was still a 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 still in fairly beleaguered state. And by the way, at that same point in time, 36% of the S&P’s 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. And that has had the effect of bringing the weight of these five names now down to a low 20s. We still have a ways to go. But I think that could represent the more benign way 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 that's a prospect that represents a high risk at this point.

Benz: Last question. You're expecting the international stock market to wrest leadership from U.S. stocks. So, explain why 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 that we think their stock markets 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 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, not perfectly timed to Dec. 31 will end U.S. outperformance and Jan. 1 will start non-U.S outperformance, but that 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. We've got the benefit to some non-U.S. markets have what 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 U.S. is probably a thing of the recent past.

Ptak: Liz Ann, this has been so illuminating. Thanks so much for sharing your time and insights with us today. We really appreciate it.

Sonders: My pleasure.

Benz: Thanks so much, Liz Ann.

Sonders: Happy to be here. And thanks for the conversation. Really appreciate it.

Ptak: Thanks again.

Thanks for joining us on The Long View. If you liked what you heard, please subscribe to and rate The Long View from Morningstar on iTunes, Google Play, Spotify, or wherever you get your podcasts.

Benz: You can follow us on Twitter @Christine_Benz.

Ptak: And at @Syouth1, which is, S-Y-O-U-T-H and the number 1.

Finally, we'd love to get your feedback. If you have a comment or a guest idea, please email us at Until next time, thanks for joining us.

(Disclaimer: This recording is for informational purposes only and should not be considered investment advice. Opinions expressed are as of the date of recording. Such opinions are subject to change. The views and opinions of guests on this program are not necessarily those of Morningstar, Inc. and its affiliates. Morningstar and its affiliates are not affiliated with this guest or his or her business affiliates unless otherwise stated. Morningstar does not guarantee the accuracy, or the completeness of the data presented herein. Jeff Ptak is an employee of Morningstar Research Services LLC. Morningstar Research Services is a subsidiary of Morningstar, Inc. and is registered with and governed by the U.S. Securities and Exchange Commission. Morningstar Research Services shall not be responsible for any trading decisions, damages or other losses resulting from or related to the information, data analysis or opinions or their use. Past performance is not a guarantee of future results. All investments are subject to investment risk, including possible loss of principal. Individuals should seriously consider if an investment is suitable for them by referencing their own financial position, investment objectives and risk profile before making any investment decision.)

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