Charles Schwab's Liz Ann Sonders stays bullish but warns of market volatility

Five months ago, when Liz Ann Sonders' job description expanded beyond chief investment strategist at Charles Schwab Corp. to include heading the investment committee for Windhaven Investment Management, her workload might have technically doubled. But she appears to be managing it by shedding some responsibilities and overlapping the work where possible. But even with the added asset management responsibilities, the wildly popular, often-bullish and straight-talking Ms. Sonders has not taken her eye off the kinds of macroeconomic issues for which she is most known. InvestmentNews: How good should investors feel about the Federal Reserve winding down its quantitative easing program? Ms. Sonders: I've had a little different view than a lot of people on the rounds of quantitative easing. I think QE1 was necessary, but with QE2 the benefits were starting to get questionable and eventually we got to the point where the costs of QE were going up and benefits were going down. One of the negative effects of the later rounds of QE was on confidence. I was wondering when we were going to stop treating the patient like it was still in the trauma room. Not having been a big believer that QE was the only reason the stock market did well, I personally think its demise is a good thing. InvestmentNews: Do you consider the $4.5 trillion balance sheet that the Fed built up another form of quantitative easing? Ms. Sonders: At least until we get the first rate hike, I suppose the balance sheet is a different level of buying pressure. The benign scenario is that the balance sheet will wear off via maturity of the bonds over time. Maybe that's a naïve assumption. It won't be a perfect world, but it never is when the Fed moves from loose policy to tight policy. The good news is, I don't think the risk of a recession is high at all now. In fact, it's extremely low. InvestmentNews: When do you expect the Fed to start raising short-term interest rates? Ms. Sonders: The consensus is still mid-ish 2015, and some people think the Fed could hold off till 2016. We have no reason to be outside the consensus. But when you listen to people pontificate about the Fed's policies, it's almost like they believe the Fed knows what they're going to do and they are just deciding how to communicate that. I truly believe the Fed's next move will be data dependent. If we stay on a path similar to what we've been on, including decent job numbers and some positive economic data, the likely scenario for a rate hike will probably be June. Presumably, they'd like to hike rates during a Fed meeting when they also have a press conference so they can talk about it. But I think it's silly for anyone at this stage to try and forecast exactly when the first rate hike will be. InvestmentNews: Do you believe the U.S. economy is strong enough to be able to absorb a rate hike? Ms. Sonders: Leaving aside the negative growth of the first quarter, which was mostly weather related, the last couple of quarters have been pretty good. Overall, the economy has suffered from the drag of slow government-sector growth, but we're starting to see a narrowing of spread between private- and public-sector growth. If you get to 3% or more growth, it may not please everybody, because it's not unbelievably robust growth, but it's not a bad environment for the stock market. I believe we're shifting into a phase of growth that is less consumer driven and more investment driven with more business capital spending. That tends to smooth the ride a little bit. InvestmentNews: Do you have an outlook for the price of gold, which has been falling? Ms. Sonders: Gold benefitted from concerns about the dollar being able to maintain its reserve status, and about China potentially turning tail and backing away from buying U.S. debt. But now the dollar is seen as a pretty strong currency and there aren't many people still saying the euro is going to replace the dollar as the reserve currency. InvestmentNews: Oil prices have been falling to levels not seen in years, which should feel like a pay raise for consumers. But is there a downside to cheap oil? Ms. Sonders: A stronger dollar means weaker oil prices. But there's a heck of a lot more to it. There's the impact of global demand, including a plunge in demand by China. There's been a huge surge in supply, courtesy of U.S. production. It's not all good news. We've seen a couple of oil companies already come out saying the lower oil prices are hurting earnings. But the thing to keep in mind is that the break-even level for 98% of U.S. crude oil production is a price of below $80 a barrel, and we're not at that point. And 82% of U.S. oil production has a break-even price of below $60. I think you might also see companies finding ways to produce this stuff at even cheaper levels in order to keep this thing going. So, the cheap oil is mostly good, even if it's not all good. InvestmentNews: What kind of economic changes or fallout do you see coming out of the mid-term elections? Ms. Sonders: If the Republicans take the Senate and keep the House, I think corporate tax reform goes to the top of the list and that's a stock market positive. I think that would be the biggest near-term positive for the markets. InvestmentNews: What are some of the biggest risks you see facing the financial markets? Ms. Sonders: There are a variety of them, including geopolitical risks. So far the market has been able to muscle through ISIS, Ukraine, Russia and Ebola. But a significant escalation of any one or more of those would not be good. I'm also a little concerned about some form of debt crisis coming from the level of public sector debt. We're not out of the debt problem woods yet, and that troubles me. InvestmentNews: You talk often about the trend toward “onshoring” that has manufacturing moving back to the United States. What's the status of that trend? Ms. Sonders: It is absolutely happening. When you look at the cost differential between here and over there, wherever there is, the wage gap is still about 30%. But when you look at all measurable cost that compare producing something here to somewhere else, the so-called total landed cost gap has narrowed to about 15%. The U.S. has always had the benefits of the rule of law, accounting transparency, deep/liquid capital markets, etc., but those benefits were offset until recently by the huge wage cost differential. It's not just anecdotal, it's absolutely happening. And that also includes non-U.S. companies looking to set up shop in the U.S. InvestmentNews: Where do you see the strengths and weaknesses outside the United States? Ms. Sonders: There are a couple of interesting places. We like China. They have a reform agenda and are looking to reform their economy to be more domestic-consumption oriented. They are also trying to gently prick the credit bubble without causing too many problems. Using the BRICs as the four biggies, we like India and China, but not so much Brazil and Russia. The theme we've had for investors that want to take a more tactical approach to emerging markets is looking at the energy consumers that don't have a credit account deficit. Europe gets interesting sooner than later, but it's not there yet. And Japan looks close to finally pulling itself out of decades-long slow growth. InvestmentNews: In July, you took over as head of the investment committee at Windhaven Investment Management. Are you now more in the money management business and less about the chief investment strategist role, for which you have become known? Ms. Sonders: There's a lot of commonality in the two roles. The money management component is very exciting and a few things have been taken off my plate to accommodate that. I'm no longer involved in writing for the Investment Ideas series we publish because of potential conflicts of interest. I suppose I approach it as a fifty-fifty split, but it's not like I actually divide it down the middle. InvestmentNews: You have a reputation for being generally bullish. When was the last time you made a bearish call? Ms. Sonders: Well, I'm a natural optimist. But I remember my talk at Impact in 2007 was as bearish a talk as I have given in my life. I remember talking about a coming recession and seeing housing as an accident waiting to happen. I guess it was uncharacteristic of me, but I had a high conviction about it. But, then in early '09, the gut feeling I had was powerful. I thought, 'This is what bottoms feel like.' At that time, you couldn't find any optimism. Then in April the leading indicators turned, and turned sustainably. That was the aha moment that we were just a few months away from the start of a recovery. InvestmentNews: Having just gone through a stretch of volatility, what are your thoughts on the stock market now? Ms. Sonders: Right now I still think we're in a secular bull market that has a ways to go. But we're in a phase that will probably have more volatility. In this era of a highly transparent Fed, that is giving us a heads-up; we should expect a pickup in volatility and greater frequency of pullbacks. But I don't think a bear market is imminent.