Liz Ann Sonders is the chief investment strategist of Charles Schwab. Read on as we ask Sonders about the new bull market, interest rates and where she believes the best investing opportunities are in 2024.
The bull market, which recently passed its first birthday, seems surprisingly resilient but also wobbly. What's your take? If indexes suggest resilience, it's because those indexes, weighted by market capitalization, have been driven by a handful of stocks in 2023. Nearly all of the S&P 500's gains have come from seven stocks, with the rest of the market significantly underperforming the index. Even if you simply look at the S&P 500's one-year price gain of roughly 22% from the October 2022 market low, that's among the weakest ever for first-year gains. Not to mention that there's been almost no participation by small caps and a negative performance by financials, neither of which has ever happened – typically, both of those have been ripping a year after major market lows.
Does the bull market strengthen or fade away in 2024? The stock market probably has an okay year if we get more stability and less uncertainty with regard to monetary policy and, in turn, inflation and interest rates.
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For the stock market to do well sustainably – and to continue to broaden out – may require a combination of a Federal Reserve that at least remains in pause mode, inflation that continues to ease, and a bond market that calms down so we don't continue to see the kind of shoot up in yields that we saw recently. That would allow more confidence that earnings growth will turn higher, which of course is at the heart of stock performance.
Are you in the higher-for-longer camp, or do you think interest rates are headed lower soon? The recent surge in the 10-year Treasury yield has done some of the tightening for the Fed, so it's possible they're done hiking. It also wouldn't surprise me if they have another hike coming. There are few conditions presently that give the Fed a green light to pivot to rate cuts. A pause is justifiable, but pause and pivot are two entirely different things.
Without inflation having come back to the Fed's 2% target, with the economy growing and only nascent slowing in the labor market, it's hard to envision the Fed shifting from the most aggressive tightening cycle in 40 years to cutting rates. They already have a credibility problem after holding rates so low, for arguably too long.
Have we sidestepped a recession? What's your economic outlook? We've been using the term rolling recession to describe the economy. It's a more nuanced way to look at this cycle, compared with a simplistic soft landing versus recession debate. Segments of the economy that were beneficiaries of the early lockdown phase of the pandemic – for example, manufacturing, housing and housing-related industries, as well as many consumer-oriented goods categories – have had their individual recessions or hard landings. But there has been off-setting strength on the services side.
Assuming services gets its turn on the downside, the hope is that areas that have had their hard landings – like manufacturing – could provide some offsetting stability or even improvement. There had been some budding improvement in housing and manufacturing, but it looks like they're rolling over again. The best-case scenario is more of a continued roll through, segment by segment, without the entire economy succumbing to recession pressure. That said, I think an officially declared recession is more likely than not.
Will we see a pickup in earnings after multiple quarters of declining growth? The consensus of analysts' estimates suggests a bottom may be in view for earnings. The rub is that looking beyond the next quarter, those earnings estimates are not based on precise guidance from companies. Relative to the pre-pandemic era, many companies are providing much-less-precise guidance, although it's not as stark as in 2020 and 2021, when a record percentage of companies withdrew guidance altogether.
Currently, expectations are for earnings to increase 12% in 2024 over 2023 levels, and about the same for 2025. I'm not saying those growth rates are way too high and have to come down; it's just that they're not based on concrete forward guidance from companies.
What impact will higher borrowing rates have on companies? That depends on the company. We're seeing a big acceleration in the amount of corporate debt coming due in 2024 compared with 2023; it will lift again in 2025 and 2026, before settling down. That's not necessarily a calamity because many companies that have fairly high debt loads have more than enough cash flow to cover interest expense, or they can easily refinance. In many cases, companies have extended their debt maturities. Where it becomes a problem is with much weaker companies – specifically among "zombie" companies, which don't have the cash flow to fund the interest on their debt.
Where do you see the best opportunities in 2024? Sectors that look pretty good on the combination of factors that the Schwab Equity Ratings team looks at are energy, financials and materials. However, we encourage investors to go a step beyond the sector level and focus more on factors, or particular stock characteristics. We have been emphasizing quality, which includes factors such as a company's ability to cover interest payments on its debt; profitability; positive earnings surprises; and low volatility.
What's your preference in terms of company size? Or growth-oriented versus value-priced stocks? The overarching focus for investors should be on quality. With size, you've got to be more specific. The Russell 2000, a common small-cap benchmark, has 2,000 stocks in it, so it's not a monolith. Look for high-quality, profitable companies with decent earnings outlooks and strong balance sheets.
Another small-cap index, the S&P 600, has a profitability filter that weeds out most of the zombie companies. What's nice about a quality wrapper for stocks is that it typically incorporates both growth-oriented and value-oriented factors. Interest coverage, balance-sheet strength and strong free cash flow are generally considered more value-oriented characteristics. But given limited earnings growth over-all, we've also been emphasizing growth factors such as positive earnings-estimate revisions and positive earnings-report surprises.
Note: This item first appeared in Kiplinger's Personal Finance Magazine, a monthly, trustworthy source of advice and guidance. Subscribe to help you make more money and keep more of the money you make here.
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