A look beneath the surface of U.S. financial markets and the economy shows a more complex and often weaker picture than broader performance and data points suggest, according to Liz Ann Sonders, chief investment strategist at Charles Schwab.
Average stock performance is notably more tepid than stock indexes indicate, Sonders noted in an interview with ThinkAdvisor on Monday.
The moves that financial advisors suggest for clients given this and various divergent trends in the economy will depend on the investor's particular circumstances, she said.
At the beginning of the year, Sonders noted, one strategist could have said, "'I'm going to tell you, I think the market's going to rip higher in the first half of the year.' And another strategist would say, 'I think we're going to see a tremendous amount of weakness among stocks this year.' And both of those prognostications would be accurate based on where we are now."
(Schwab doesn't issue year-end price targets, she said, calling it "a ridiculous exercise.")
"What you see on the surface, if you just look at the S&P index at the index level or the Nasdaq at the index level, it looks like the market has just been on fire. And kind of a nothing-to-see-here backdrop," she said.
But a look under the surface tells a different story, she added.
While the Nasdaq has seen a 7% maximum drawdown from its year-to-date high, the average stock in that index has experienced a 37% drawdown, Sonders noted.
"Wow. So that's a heck of a lot of churn and weakness and rotation going on under the surface that you wouldn't pick up if you were solely looking at index level changes because these are cap weighted indexes, whether it's the S&P or the Nasdaq," she said.
In their recent midyear outlook for stocks and the economy, Sonders and Schwab senior investment strategist Kevin Gordon also noted differences in the maximum drawdowns from year-to-date highs in other stock indexes, including 5% for the S&P 500 compared with 15% for its average stock, and a 9% drawdown for the Russell 2000 versus 28% for the average stock.
But Why?
"If you've got the largest cap names driving performance, then it keeps the indexes afloat. But the real story is, I think, under the surface, and I think the story of what the rest of the market is doing is maybe more reflective of all these uncertainties that we're all very familiar with — uncertainty about the economy, uncertainty about the labor market, what's the Fed going to do, and … geopolitics, the elections," said Sonders.
"So when people say, 'How can the market be doing so well in the face of all this?' I say, 'Well, it depends on how you define the market. Cap-weighted indexes are doing well because of the dominance of a small handful of names," she said.
Consumption is the economy's biggest driver, "and there are cracks in the veneer of strong consumption," said Sonders. She anticipates the cracking will continue "because the excess savings story has dwindled. It's hard to judge exactly what, if anything, is left."
It's clear that excess savings from pandemic stimulus is gone on the low end of the income spectrum, while some research suggests savings remain for higher income consumers, she said. That's why defaults and serious delinquencies are picking up and appear more concentrated in subprime areas, whether auto loans or credit cards, Sonders noted.
She also noted bifurcations in consumer sentiment, with confidence much weaker among lower income earners.
Jobs Data Sparks Psychological Effects
The labor market is the most important factor now both for the economy and as a trigger for change in Federal Reserve policy, according to Sonders.
Sonders expects a weakening labor market, with various ripple effects.
The Fed wants "to kind of crush job openings without crushing jobs," she said. "And job openings have come down quite significantly. But we are also in a trending higher unemployment rate."
The unemployment rate affects average individuals "because it's concrete, they can grasp it. And that tends to have psychological impacts, not just actual impacts," the chief investment strategist said.
Sonders also noted differences between the payroll survey, which measures jobs at businesses, and the household survey, which generates the unemployment rate. The estimates from the two surveys differ due to distinct survey methods and definitions.
While the payroll survey has recently shown employment growth in several industries, the unemployment rate from the household survey most recently changed little from the previous month, at roughly 4%, and was higher year over year.
"The average person knows and sees, 'Oh no, the unemployment rate's going higher.' That leads to less confidence about keeping a job, finding a job if you don't have it. That feeds into desire to consume," said Sonders.
