Charles Schwab Chief Investment Strategist Liz Ann Sonders tells Yahoo Finance Live that the economy is not out of the woods yet. Sonders points to the weaker than anticipated ISM Services data. The services industry is a larger employer than the manufacturing sector, so with that data starting to show some weakness, the "labor market hit" to the economy "is still yet to come," says Sonders.
- We are almost halfway through the calendar year, and it's safe to say, a lot has happened so far. Tech stocks surging this year, as a wave of interest in AI is making investors bullish on the sector. The Senate voted to approve a bill that raises the debt ceiling for two more years. And the Federal Reserve paused its campaign of interest rate hikes, marking the first break after 15 months of consecutive increases. But are we out of the woods just yet?
Liz Ann Sonders, Charles Schwab chief investment strategist is still with us. So are we out of the woods yet? You just talked about some of these indicators. And of course, NBR, when they assess, whether it has been or is a recession, it can be often backward-looking. So are we out of the woods yet?
LIZ ANN SONDERS; So for the economy, no, I don't think we're out of the woods yet. As I mentioned, we're starting to see some minor cracks in services certainly witnessed in a metric like the ISM non-manufacturing index, which by the way, covers more than just services. A lot of people don't realize that ISM manufacturing is just the manufacturing sector. ISM services, which is formerly called non-manufacturing, is everything else other than manufacturing. So it's a pretty broad look. But that dipped more than expected and is sitting just above that expansion-contraction line.
The rub of services getting hit more is that they're a larger employer. And so I think the labor market hit is still yet to come. And I think we're at a moment of truth here for companies as they look at what many perceive to be pricing power was really just directly tied to higher inflation. So you had very strong nominal revenue growth, but it was more than all accounted for by inflation.
There hasn't been any real revenue growth over the past year or so. And now, that inflation is coming down and other costs are coming down. But with the demand, companies are going to say, how do we protect our margins? And for many companies, the largest cost is on the labor side. They've been hesitant to do it. There's the labor hoarding notion, and I think it has validity, but they have been cutting hours.
And I think now, we're at that moment of truth to see whether companies will maintain that confidence. And eventually, we'll see a pickup and maybe even take the hit and profit margins by maintaining worker roles to the same degree that they have in the recent past. So I think the next month or two-- especially with second quarter earnings season coming up, I think what companies are saying about their cost structure specifically labor will be an important tell, whether that is the potential proverbial next shoe to drop.
- I mean, that's a really interesting question too. Because are they so traumatized by the difficulty finding labor during the pandemic and after, that that is going to inform the decisions they make now? I want to zero in on profit margins, which you just highlighted. There have been some prominent calls lately that have said, we're going to see a pretty steep tumble, perhaps a double digit tumble in profits from here through the end of the year. Do you see that happening? And then how is that going to inform what we see on the stock front?
LIZ ANN SONDERS; I think the path of least resistance for the second half of the year in terms of consensus estimates is probably still lower. When you look at the historic relationship between things like lending standards, PMI's, moves in the 10-year yield, they all track pretty closely subsequent trends in earnings with different lag times. And it suggests that at least second half of the year estimates are probably a little bit too high.
Now, overall, calendar year '23 estimates have been trending higher, but that is all accounted for by the better than expected first quarter earnings season where analysts just set the bar too low, companies exceeded those expectations. So a lot of people, when they look at 2023's estimates coming up, they think, OK, the clouds have parted. The skies are clear. But second quarter, third quarter, fourth quarter estimates have all been coming down. There's just been a bigger adjustment associated with what has already been reported.
And I think the other unique thing is that, remember during the pandemic, a record percentage of companies withdrew guidance altogether. They just said, we're not even going to try to be precise with guidance to our analysts because of the unique uncertainties associated with the pandemic. Now, companies have picked up in terms of those providing guidance, but they're doing it a little more loosey-goosey. And I think many companies are using the pandemic as an excuse to say, we're not going to go back to that game of quarterly guidance to the sense because that's not how companies run their business.
The result of all of that is, I think, analysts are not making adjustments to far out. They're making adjustments maybe a quarter out particularly when they're hearing from their companies during reporting season. So they might adjust the next quarter's numbers, but keep their cards closer to the vest until they get more direct earnings season commentary from companies. So that forward consensus might not be as, for lack of a better word, valid as it has been in the past.
- Liz Ann, I want to just expand this conversation a little bit in terms of the impact to the market. We've seen the market head into a bull run. The S&P is doing better than a lot of people expected earlier this year, and certainly breaking out of certain technical levels. In terms of where the rally is headed, do we think this is a head fake or do we expect more participation from, say, the small caps? What's your view?
LIZ ANN SONDERS; So we've started to see improved participation, but we definitely need to see more of that. When May ended, you had only 15% of the S&P was outperforming the index itself over the prior three months. That was a record low, even exceeding what was seen as a very concentrated market back in the 1999-2000 period of time.
And yes, we have started to see a pickup in breadth, but not for a long enough period of time, nor has it surged enough that you can breathe a sigh of relief. It's also the case that we're in a so far improving breath environment, but with the market having done very well technically overbought and sentiment conditions starting to get fairly frothy.
That's, I think, importantly in contrast to what was happening in October where the indexes like the S&P and the NASDAQ took out their prior June low. So on the surface, it looked pretty ugly. But breadth, under the surface, was actually improving. That positive divergence is the best of all worlds because you don't have the overbought market. You have negative sentiment, which acts as a contrarian indicator.
So I think we do need to see more broadening out. Because a market that is driven by, in this case, just seven stocks, if the other stocks are significantly underperforming, not just hanging in there, that's when you get a bit of risk of convergence. So I like the broadening out, but I think we need to see more of it.
- We'll see if it happens throughout the summer. Liz Ann, always good to catch up with you. Thank you. Liz Ann Sonders is Charles Schwab chief investment strategist. Have a great evening.
