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New COVID variant and Fed tapering created a ‘double whammy catalyst’ for volatility: Strategist

Charles Schwab Chief Investment Strategist Liz Ann Sonders examines what economic indicators should be watched as pressures from the Omicron variant and the Fed's tapering schedule weigh on market volatility.

Video transcript


BRIAN SOZZI: Before you know it, the calendar will read 2022. And who knows, at this rate, the S&P 500 may be down another 5% before that calendar turn happens. So how should you be positioned into the new year with stocks under major pressure right now?

Liz Ann Sonders is the chief investment strategist at Charles Schwab and joins us now. Liz Ann, always nice to see you. We were just talking about the Federal Reserve's, I would say, hawkish shift yesterday, led by Fed Chair Jerome Powell. As you look towards next year, we could have an inflation-fighting Jerome Powell. Does that set the stage for below-average returns for stocks?

LIZ ANN SONDERS: Well, first of all, I'm not sure it really was such a hawkish shift. I think the announcement at the November FOMC meeting of the tapering starting, but the $30 billion a month just being for November and December, at least implicitly, suggested the Fed was going to consider a faster pace of tapering. And that really started to get built into expectations, until, of course, the news on Black Friday or Bleak Friday of Omicron. And the market made an adjustment then to move away from that further tightening.

I think just what Powell did was more explicitly keep that on the table so I'm not sure if it was a big shift. But yes, I think at this stage in the economic cycle, in the market cycle, the move from very loose policy to tighter policy, not tight policy, I think has been a factor in volatility. And you add that to an environment where we started to see a tremendous amount of speculative froth again, and then add to that Omicron, you get the sort of double-whammy catalyst that can sometimes cause an eruption in volatility when you have that excessive optimism and high level of complacency. So I think that's been the recipe for the kind of moves and shifts we've seen in the market.

JULIE HYMAN: Liz Ann, as you pointed out in your 2022 outlook, we have seen a correlation between stock prices and bond yields really for the past several decades, right? So as we go into next year, are we going to continue to see that? Presumably yields are going to move up as the Fed does, indeed, taper and then raise rates. Are we going to continue to see that same sort of correlation?

LIZ ANN SONDERS: So, I mean, I think that's probably one of the more important aspects of the outlook that we put together. And keeping an eye on that correlation may end up being at least a partial answer to this question that's out there as to whether we're not just in a short-term inflation spike, but whether we're moving into a more secular inflationary backdrop, because to the point about yields and stock price correlation, for 30 years, starting in the late '60s, those were negatively correlated. And as a reminder, when bond yields are going down, bond prices are going up, which meant that the returns in bonds and stocks moved in the same direction. So diversification, at least across those two asset classes, became more difficult. Then for the 20 years starting in the late '90s, we've had a positive correlation between bond yields and stock prices.

A couple of months ago we dipped back into negative territory. We popped back out. But if we move back into negative territory and stayed there for a somewhat sustainable period of time, I think that could send a message that the secular backdrop is changing.

We know that that 30-year period of negative correlations was an environment of, obviously, higher inflation, but greater frequency of supply shocks, versus the pass 20 years that it's been more prone to demand shocks, albeit not terribly significant ones. So that is certainly something I'm keeping a close eye on in 2022. I don't have a forecast for whether that's going to happen. But I think were it to occur, that would be a pretty definitive sign that the backdrop has moved away from being disinflationary, like the last 20 years.

JULIE HYMAN: And Liz Ann, I would say, by the way, that's one of the charts that you have and your outlook for next year, which I encourage everyone to read. It's available. Anyone can read it on the Schwab website.

And one of the other charts that caught my eye was about consumer expectations minus their present situation, how they feel right now subtracted from how they expect things to be and whether that's a precursor for recessions. And we just we're talking a few minutes ago on the show about the yield curve and that predictability for recessions. You're looking at this one. I mean, the right side of this chart doesn't look so great on that front. So what is the likelihood that we're going to enter another recession?

LIZ ANN SONDERS: Well, one caveat with a statistic like this-- and it's not to suggest it's no longer important, and yes, you can see based on those gray bars, which are recessions, that never in the history of this data have we been at this low a spread. And it did pop up yesterday with the release of consumer confidence, but not by much. We've never been at this level without it being a precursor to a recession. But, of course, you add into the mix now the virus and variant news, Delta, now Omicron as a factor maybe putting more downward pressure on future expectations than has been the case in the past, where it's really been more about economic conditions that were putting downward pressure. So it could be a bit different this time.

And I think in terms of the yield curve, yes, it has been flattening, but it's nowhere near the point of threatening an inversion, which has historically been another pretty strong recession indicator, but with some lead time. So I think we need to be on watch for these things in 2022. But it's not on the basis of having a recession view. But I think it's time to start pulling out the indicators and at least keep them on your mental checklist because of where we are in admittedly a very unique cycle.

BRIAN CHEUNG: Hey, it's Brian here. And kind of drilling down on the consumer side of things, what are you seeing in terms of the behavior for the shift between goods and services? Because another call that we had been hearing earlier in 2021 was, well, as the virus gets contained, you're going to see that shift from goods to services, which hasn't necessarily happened. Is it because people just don't want to get out of whatever system they put up for their pandemic haircuts?

LIZ ANN SONDERS: Well, we went to-- we saw a divergence in the two. And particularly during the shutdown, for obvious reasons, we saw a massive surge in demand and consumption on the goods side at the early stage of the pandemic. That, of course, was because most on the services side was shut down. So we didn't have access to consumption on the services side. So it all filtered into goods.

We had started to see a bit of a convergence between the two as we went through the reopening phase. But it's been with fits and starts, especially because of the Delta variant, which didn't cause lockdowns, but it does change behavior with regard to services. We don't have enough detail on Omicron to know whether we're going to go through the same type of hit to services demand or consumption. But we may have arrested that convergence for now, at least as we wait to get more details.

It's been our view, though, that if demand does shift more definitively to services and services remain open and available for everybody that it wouldn't be additive to goods consumption, that it would take from goods consumption, because goods consumption has been so strong. We're not meeting that demand from a supply chain standpoint, but we're well above trend line, suggesting that we're more likely to see an ease. And if you look at things like buying intentions, whether it's for homes or autos or large household durables, those have absolutely plunged because prices are so high. It's putting some downward pressure on demand. But until we have more information on Omicron and what restrictions get put in place at the global level, it's going to be hard to make a judgment on what those trends look, like at least in the near term.

BRIAN SOZZI: I really enjoyed your outlook piece. And again, as Julie mentioned, you can read more about it on the Schwab website. Liz Ann Sonders, chief investment strategist at Charles Schwab, always good to see you.

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