Transcription
This does remind me a little bit of the 1990 period where we did see a spike in oil prices. We had Middle East conflicts. We had credit concerns that came as a result of the late 80s LBO boom. It was dismissed as yet another geopolitical nothing to see here. And you did end up having both economic dislocations and market dislocations. Not extreme, not '08 like, but to me, there are shades of that 1990 period.
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Very pleased today to be joined by Liz Anne Saunders, Chief Investment Strategist at Charles Schwab. Liz Anne, so great to see you. Welcome to Monetary Matters.
>> Nice to see you. I always love our conversations. Thank you.
Liz Anne, you write recently that the 2026 period presents one of the most analytically rich internal market environments in many years, in part because headline indices are obscuring rather than revealing underlying stress. What is the stress you were referring to there? And how might it be obscured by the headline indices?
>> Let's just put some numbers on it first, and then I can talk about the why. Um, so you've had, as as you and I are taping this right now, we've had at the index level, the S&P's maximum drawdown so far year-to-date is 7%. So, not not not getting really close to correction territory. It's a little bit bigger for the NASDAQ at the index level. The maximum drawdown has been 9%. Um, but under the surface, it's where it gets more interesting. So if you look at the average member-level maximum drawdown, so you go through, you know, all the stocks in the S&P, look at what their individual maximum drawdowns have been, and then take an average, that's negative 17% for the S&P 500. And in the case of the NASDAQ, it's negative -31%. So you've had this rotation and churn where you've where you get these pockets of weakness. Sometimes they're idiosyncratic with a couple of names. Other times they're specific to an industry like the software industry where you get, you know, correction if not bear market level declines. It's just offset by strength elsewhere. So rotation and churn has been happening, and it's masked by more benign, a more benign drop at the index level. Now, frankly, I think most investors would choose that kind of process where maybe you you correct excesses, whether it's valuation excesses, sentiment excesses, maybe a, you know, a fundamental narrative change through a process of rotation as opposed to say the NASDAQ falling by 30% in one fell swoop. So, it's not a bad way to go through this process, but it does tell you that the fuller story is told under the surface of these cap-weighted indexes.
And we will get to into the war and the impact on oil prices quite quickly. But you know, Lizanne, if if I had run into you uh at at a conference maybe in November and December and we we both knew that there would be an oil shock in the first quarter of this year. Um, perhaps I might have speculated that the S&P would have been down more. The thinking being, okay, you know, companies that aren't in the energy sector are probably going to be a little bit challenged. And even though the energy sector, you know, looks poised to do great with oil up at $100 or perhaps even higher, um, you know, the oil sector just as a percent of the S&P 500, the energy sector I should say, is just not large enough. And yet, as you say, the the S&P 500 is, you know, not nowhere close to down, you know, in a bear market 20%. Why is that?
>> Well, I I don't know that I would have speculated that we would have a bear market as a result of some sort of military conflict and a spike in oil prices. I think probably the conversation would have continued on in terms of what the what the actual mechanics were around the conflict, what the longevity of a move higher in oil prices where we sit right now. Yes. Uh, I am a bit surprised that the market hasn't suffered a little bit more. But wait, what it may be reflecting is that there's pockets not just in the market but also in the economy that are no one's immune, no industry, no company, no individual is immune from the impact of of the spike in oil prices and how that filters through to inflation and the economy. But what we haven't yet seen is any deterioration in forward-looking earnings estimates. Now, some of that is because we're just not at a point where analysts sort of have their feet put to the fire as you approach earnings season where they've got to actually take, you know, a racer to the paper and say, "Okay, we need to make those uh earnings adjustments." I think as we get into the beginning of April and we're closer to reporting season, you might see those adjustments. In the meantime, we've obviously seen an upward bias to estimates for the energy sector, but we've also seen significant upward bias to the estimates for the technology sector. And I think that's a combination of well, maybe this sector is a little bit more immune to the military conflict, the war in Iran and the the effect of of energy prices. But you've also had a, a actually literally a couple of stocks that have pre-announced huge upside and that boosted earnings. So I think if we had seen a more direct deterioration in the forward assumptions for that, you know, ever-important factor of earnings growth, then I think the hit to the market would be more severe. Another reason that upcoming earnings season is going to be an incredibly important one.
>> If the price of oil stays at uh $100, WTI is a little bit lower, but you know, Brent is at $100. If it stays around there, what do you think the impact will be on the economy, on the market, and how will it be the transmission channel? Will it be that companies themselves like United uh Delta Airlines companies, you know, they they are feeling the pinch, or is it that consumer sentiment and consumer uh savings and and therefore spending is sapped by higher oil prices and then through kind of a macro channel that impacts?
>> Yeah, I mean, I I'd say to all of your, you know, possibility examples, the answer to all of them is yes. You know, that is that is the feeder mechanism. Um, I I think in terms of global impact, there are unquestionably pockets of the global economy that are more directly and quickly impacted by the lack of oil getting through the Strait of Hormuz. Uh, many Asian nations being a big part of that. You also see that reflected in the still fairly widespread between Brent crude oil prices and WTI prices. WTI being the domestic uh benchmark. And in terms of overall, you know, petroleum products in the United States, we are a net exporter. That said, we are still a net importer of crude oil because of certain types of crude oil. So sometimes the the follow-on to that we're a net exporter is nothing to see here. There's no impact on the US economy. Maybe a on the margin less of an impact, but obviously it feeds through the consumption channel through gasoline prices, through electricity prices, which were already elevated and a concern for consumers. You mentioned into travel, and it's not just airlines and the impact that that has on travel and people's willingness to spend, and that's not just at the consumer level but the business level. But there's also, think about how much in terms of goods are transported in whatever form over rail, over truck, over sea, that is impacted. So that feeds into consumer prices. We're not just talking about oil going the Strait of Hormuz. We're talking about petrochemicals. We're talking about fertilizer. Increased fertilizer prices feeds into higher food prices, which feeds into that consumption channel. You know, consumer sentiment or consumer confidence, whatever measure you're looking at, has already been pretty de-rated, never really sort of pulled itself out of the the pandemic levels. The hard data has uh has always been stronger. Consumption data has been stronger. Now, I think we're we're clearly not likely to see a pickup in consumer confidence, but we could start to see more of a reigning in on the consumption side. So, the longer it lasts, the more it turns into a demand, overall economic demand destruction story.
If you wanted to find something good about that, it probably lessens concern that has crept in recently that the next move by the Fed might actually have to be a rate hike, not a rate cut. That the fact the prospect that the Fed was is going to hike rather than cut interest rates has increasingly been priced into the market. What do you think about that?
>> So, I I think it's premature. That said, you know, the the the Fed is operating with with being data-dependent and unique among global major global central banks is the dual mandate that the Fed operates with. And right now, the two sides of their mandate are in conflict with one another. We're we've seen weakness show up in the labor market even in advance of the the war in Iran. Um, but we've also seen upward pressure to inflation, particularly the inflation metric that the Fed pays most close attention to, which is personal consumption expenditures, the PCE measure, both at the headline level and at the core level. So, there was already discomfort in inflation not coming down to the Fed's target, and that pre-dated the war in Iran. And then of course, you've had the most recent Fed meeting. No surprise that they didn't do anything. They certainly didn't telegraph rate hikes, but that's what started to get priced in, especially with the recent intraday spike on the part of Brent oil up to close to 120. I think that really kind of rattled uh a lot of market participants, and you took those expectations of cuts fully off the table and maybe a concern that uh a hike might have to be considered.
Quite often, particularly in 2022, the stock market responds and cares very much about what's being priced into the Fed fund futures and the bond market. But as as you've been pointing out, the real driver of the the markets since the war started uh in late February has been oil prices. And you show the intraday correlation between Brent crude and the S&P 500 has been very negative. Yes.
>> So how much of the S&P 500's market returns over the past month have been kind of a one-way bet uh in the opposite direction on the price of oil? What does that say about where we are right now? Other than, you know, a day this week where you had a big rally in the market in part because you had a 10% drop in oil prices. So that intraday rolling intraday very steep inverse correlation, I think is going to persist. And that, of course, means you you get the the benefit on the upside for the equity market to the extent you get some downside in oil prices and vice versa. And it's it's hard to see what breaks us out of that inverse correlation. Historically, even as recently as the first two months of this year, I I know you referenced the intraday correlation. I'm sure you've seen the the chart. You you had fits and starts at times intraday. There was a positive correlation, negative correlation. That wasn't because the two markets were trying to figure each other out. It just there were a million other things going on, and the market wasn't keying off of oil prices that have been just kind of hanging around, you know, $60ish uh per barrel in WTI. So on certain days it happened to be a positive correlation. Certain days it happened to be a negative correlation. It was almost more arbitrary. Now clearly we're seeing that impact. And I think what's sort of reinforcing that or maybe exacerbating that steep inverse correlation has to do with the mechanics of the market in this type of environment. You've got traditional retail traders, that's distinct from individual longer-term individual investors. But retail traders now account for about 25% of trading volume. Then you add in other what I've been calling short attention span money. So systematic hedge funds, the CTAs, which is commodity trading advisors, uh, long-short hedge funds, all operating with pretty minuscule time horizons and kind of playing the other side of positioning. And you get these really swift moves that sometimes can turn intraday on a dime. It is a tricky environment. Uh, there's no question about it.
Lizanne, I I know you prefer to analyze things from from the lens of factors rather than sectors. So, I'm I'm going to get to that in a moment about factors, but if we could just stick with this this the sector thing, you got this great chart showing how the year-to-date performance of the energy sector uh has been uh over over 30%. And meanwhile, other other uh sectors have have struggled massively and and you know, the the percentage of energy companies that are over a 50-day moving average is 100%, as opposed to in the industrials, it is uh something like uh 13%. So that does not inspire a whole lot of confidence. How how are you thinking about the the energy sector, which you know does appear as, um, kind of the ultimate hedge for for what's going on?
>> Yeah. So we have we we have sort of a a range of views at the sector level from, you know, the least favorable to the most favorable, and energy kind of falls in that sort of high neutral to somewhat favorable uh range. Our time horizon when we express views at the sector level is in the 6 to 12 month period of time. If if I was a trader and I was talking to you now about the energy sector, I'd probably be a lot more optimistic having a more reasonably long time horizon given what has been uh a pretty significant amount of outperformance and almost, you know, parabolic nature of the move. I think you have to be a little bit careful uh there. So a lot of it is sort of the context of of time frame and and time horizon, and you know, we we do publish sector views. Uh, Schwab has sector views. You can literally just, you know, Google Schwab sector views and you can see where the scale is on all the sectors. We've had a favorable view in areas like communication services, also industrials. Um, our least favorable has been more in the real estate and the consumer discretionary. But when I talk about factors, I I think it should be at least as an overlay to what is a more monolithic sector recommendation. You know, when you have a highly correlated market and you have an era like the Mag 7 being sort of the only game in town, monolithic investing made sense. You could buy, you know, a cohort like the Mag 7 or you could buy tech because stocks were highly correlated within the tech sector. Now we're in an environment, notwithstanding the last month with the the onset of the Iran war, but you've seen correlations break down, dispersion go up, and even within a single sector, a much wider array of uh performance, which the factor-based analysis is just applying. You know, factors is just another word for characteristics. So instead of just making a monolithic call, look for certain characteristics within any of the 11 uh sectors. And and there's been more consistency in terms of performance at the factor level than there has at the sector level. Sectors kind of swing wildly on a week-to-week and a month-to-month basis.
>> And what has been the the factors that are causing that dispersion? If you have, you know, a sector X or sector Y, and you have the top performing stocks in that sector versus the bottom ones, what factors explain the outperformance? Is it value? Is it quality, momentum, or or?
>> Yeah. So, interestingly, let's just talk about the past month because that seems to be uh in focus for a lot of people given the change in market behavior in light of the the war in Iran. And one of the better performing factors, interestingly, and this goes again back to the the dominant players in the market and positioning, has been short position, meaning some of the best performers have been the stocks most heavily shorted.
>> And that's in part because some of these really short-term traders, including retail traders, are back to some degree in that, you know, meme stock era 2020 mindset. That's almost, you know, stick it to the man. They're thinking, you know, how do I play the other side of the trade? Um, look to where short interest is high and make a bet on the necessity of short covering. So, they're inherently a lot of the characteristics, other characteristics of heavily shorted stocks tend to be lower quality, weaker balance sheet or lower interest coverage, or maybe higher valuations. But in an environment like this, where there's so much flip-flopping happening in terms of positioning, you'll get a move like that that is arguably lower quality if you're thinking in a traditional way, but it's easily explained by what's happening. You see it not just in the equity market. You know, gold was on an absolute tear prior to this. You would think an asset class like gold would do incredibly well when you're at the onset of a war, you're in a military conflict, that flight to to safety and protection. But the more recent move up in gold had gone parabolic. It was very much driven by performance chasing and FOMO. So now you're sort of getting traders playing the other side of that. So it's less about fundamentals and more about uh technicals. So that's a way to think about factor investing in this environment. We still think you want to have a quality focus, but the quality component that we think is most important now is profitability. In fact, another thing that's happened that's a very important difference between this year and last year, to just putting kind of calendar year terms, is within the Russell 2000, um, which in the past year, notwithstanding the last month, really had quite strong performance, but within the Russell 2000 in 2025, non-profitable stocks were up 20%, profitable stocks were up only 10%. So double the performance by the non-profitable stocks. That has flip-flopped this year, and now it's the profitable stocks that are handily outperforming the non-profitable stocks. So I think in this environment, if I would say sort of one category of factors of focus for us is that profitability, not just simple, you know, forward earnings, but, um, you know, stability and profit margins, a positive outlook, positive earnings revisions looking ahead. Um, so that's the area of factor focus that that we have been resting on recently.
>> So the highly shorted stocks, because you know hedge funds short them, tend to be the ones that have lower profitability, perhaps are losing money?
>> No, no. Well, I was talking about profitability in terms of last year versus this year. So leaving short interest aside, separate from that, what I was talking about is within small caps, last year was a story of low quality, given that the unprofitable components or constituents within the Russell 2000 had twice the positive performance as the profitable constituents. Complete opposite this year. This year, the profitable constituents within small caps are handily outperforming. You would think that that would generally be the case. It was not the case in a year like last year.
>> Sorry. It's interesting about the heavily shorted thing because I think what it, if you were telling me only thing you told me was that highly shorted stocks are outperforming, I would say, oh, that reminds me of, you know, 2021 in terms of kind of a speculative excess, a very, very strong bull market. But it's interesting that in the challenging market we've had over the past month, that highly shorted is performing well as a factor. That's fascinating.
>> Yeah, it it um, that's why I think one of the things that this reflects is when you when you think about kind of the retail trader cohort. I I don't want to generalize and say they're not paying any attention to macro stuff, but they're paying less attention to the stuff that we all live, eat, and breathe on a day-to-day basis. Concerns about geopolitics and the war and the impact of energy prices and the feeder into inflation and what's the monetary policy reaction function and how does it hit the consumer. Um, it's much more of a sort of blinders on, what is my trading strategy today? Um, which at times can adjust based on narrative changes from a more macro perspective, but that's not really the primary driver on a, you know, minute-to-minute, hour-to-hour, day-to-day basis for many of these trader cohorts.
>> So, would you characterize yourself as a permabull on quality? In other words, the companies who are, you know, perhaps processing payments on credit cards have a higher profit margin than the the banks who are making the credit card. If you're an oil company, you have a and you have a royalty, all you do is own land. You have basically, you know, very, very little costs. You're going to have higher profit margins than the companies that have to plow billions of dollars into the ground to actually produce the oil. So, you'll be higher quality. You know, those types of companies have outperformed, um, over time. Would you characterize yourself as, you know, almost all of the time you are bullish on the quality factor, or is there a time it?
>> Not really. Um, so yes, over the very long term, do the stocks of higher quality companies outperform lower quality companies? 100%. So if we're talking, you know, 5, 10 year time horizons, yeah. But there are really important times where actually going down the quality spectrum, whether it's to weaker balance sheet companies or companies that have, you know, lower interest coverage, that have lost their profitability. There are times where there's a benefit in doing that. And in particular, it's when you've gone through a significant downturn, call it a recession, and the market starts to price in the recovery coming out of that. That is where the leverage is greatest, often where the pain has been most acute. So there are times when you're at sort of one of those potential economic inflection points. A perfect example of that would be in 2021 when we saw the creation of vaccines, the global economy started opening back up again. The market suddenly said, "We're not in this sort of closed environment anymore. We can now start to price in whatever recovery out of a pandemic looks like." And you saw a willingness on the part of investors to go down the quality spectrum in areas and stocks and industries and types of companies that were most damaged because now when you had the opening up, they had that opportunity to see that improvement. And what I, the the overarching message around that is is a mantra I I always share with investors when I talk very big picture and try to get people to understand at times what seems to be a disconnect between what's going on in the economy and what's going on in the market, um, is that better or worse often matters more than good or bad. And as a leading indicator, the market tends to sniff out inflection points. And if you think about economic inflection points at the bottom, when things have stopped getting worse in anticipation of them starting to get better, at that moment in time, the data is at its worst. It looks awful. That's why, you know, launch points of new bull markets have often come when, typically come when the economic data looks horrific. It's because the market is sniffing out that things have stopped getting worse and starting to get better. Conversely, at the top of the V, when economic data stops getting better, starts to deteriorate, but before the deterioration actually happens, you take a snapshot. The economic data looks absolutely fabulous. Yet, through the benefit of hindsight, we can say, boy, tough to have called a bear market starting then because look at how great the data was. Better or worse tends to matter more than good or bad. So, at the beginning of a bull market, at the trough of the business cycle, when it's about to, you know, it looks like it's going to be the worst, but it's about to get better, that's when you want to own lower quality companies. So, you know, not load up on the quality factor.
>> Does?
>> Well, I don't want to say throw out quality and just load, but that's a time when there's opportunity that presents itself down the quality spectrum. It's not a throw caution to the wind, do some quality screen, you know, turn it upside down and just buy, you know, the 10 at the bottom of the barrel.
>> So, what the the fact that you really like the quality factor now, uh, what does that indicate about your overall outlook? Could could it accurately, could it be called, you know, kind of a defensive posturing?
>> Well, interestingly, I I think this is a a market cycle that we have to m that we should maybe think of what's defensive in a different way. So I think defensive often suggests, you know, consumer staples and utilities. There's this sort of direct link that people make between what's defensive, okay, what types of stocks and what sectors do they live in. Defensive is almost more of a concept and can mean different things at different times. Go back to the pandemic. Think about 2020. Um, the the call it just the first year of the pandemic when the entire global economy was completely shut down. The the only ecosystem in which we were all living. We weren't traveling. We weren't shopping. The only ecosystem was represented by the mega-cap tech companies because that was the world in which we were living. That was still operable. That was how we communicated. Those became that era's defensive stocks. That's where you went for defense, lowercase D. And I would say the same thing about momentum. This is what trips investors up too. They think of defensive as automatically meaning, you know, consumer staples and utilities, and they think momentum as meaning, oh, it's just tech stocks. Momentum is also just kind of a concept. Um, momentum just means that stocks that have been doing well continue to do well. There can be momentum in consumer staple stocks. There can be momentum in utility stocks. Um, it just means that there's momentum in what's been working continues to work. So, I think that's examples of some of the almost factor-oriented terminology, um, that can sometimes trip investors up. I think that again, we're starting to see just in the past month that maybe some of those mega-cap tech stocks are displaying a little bit of that defensiveness, um, which is not your classical area of defense.
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So, the mega caps are indicating a defensiveness, meaning that they are going down less than the market or or what?
>> Yeah. Well, we we, you know, we've seen a little bit more interest back in, you know, tech up the cap spectrum. Um, but that also had to do with that's that's where some of the pain points were most significant. So, if you're sort of trying to pick off what has underperformed to a significant degree. I mean, look at the turn that the, you know, SaaS stocks, software as a service, got absolutely hammered during that sort of era that mini era that predated the start of the Iran war when everybody was focused on the AI disruption story, absolutely crushed those stocks such that positioning was so washed out that you got almost sort of the reversion to the the mean uh trade. Um, so I think there have been a lot of of aspects to what we're seeing, what's working well, what's not working well. That in the case of energy working well, that's sort of a big duh. When you've got a huge move up in oil prices, profits, that adds to the profitability of the energy sector. But in other places, you get a combination of, well, maybe I can hide out in these names that are seen as less impacted day-to-day by higher oil prices. Or maybe it's time to trim where I have profits. If I'm, you know, if I feel concern about the market and I'm a little concerned, maybe I should take profits where I have profits. And, you know, the trader mindset, boy, what's been so damaged that maybe I can kind of pick that off for a move on the upside. So I I think it really depends on on the investor and their time horizon as to what's driving where they're finding interesting opportunities both on the buying side and the selling side.
>> Liz, I I loved I think we did an interview in 2023. You pointed out to me how, you know, everyone thinks of the growth as a factor. So a growth fund as having tech stocks because tech stocks grow their earnings, but the sector that grew their earnings the most in 2022 or, you know, one of the most was energy. So you had the uh growth index dominated or having higher share than normal of energy companies in 2022, just to show how kind of malleable the factors are not in terms of what they represent. Not only that, but
>> you know, the indexes so labeled have different index providers have different rebalancing dates. So S&P, which has their S&P Pure Growth, S&P Growth, S&P Pure Value, S&P Value, those are the four growth and value indexes created by S&P. S&P does their index rebalancing in mid-December every year. Russell, Russell 10,000 Growth, Russell 10,000 Value, 2000 Growth, 2000 Value, they don't do their rebalancing till the end of June every year. So exactly to your point, Jack, at the end of 2021, mid-December, S&P rebalanced their indexes, and S&P Pure Growth went from having all eight of what at the time we called the Mega Cap 8. So it was the Mag Seven plus Netflix. It was kind of a different cohort at at the time. Poor Netflix just got pushed aside, and then we all became obsessed with the Mag 7. But all eight of the Mega Cap 8 were in S&P Pure Growth on December 18th. On December 19th, when S&P did its rebalancing, only one was left in Pure Growth, and the other seven were then split between S&P Regular Value, S&P Regular Growth. And to your exact point, because of that, tech overnight went from being 37% of S&P Pure Growth to only 13%, and energy became the highest weighting. Russell didn't do their rebalancing till the end of June. So for the first half of 2022, you would think S&P Pure Growth and Russell 1000 Growth, we're both talking about large-cap growth indexes, would look fairly similar. They didn't look at all similar. And by the way, by the time Russell did their rebalancing, energy's growth rate had started to come down. Their rebalancing didn't lead to a significant weighting increase in energy. And even by the end of the year, you had a huge performance spread. So when I hear people generically just say, "Oh, I like growth or I like value or I'm going to be invested in or overweight," I always I always want to I I beg to ask the question, what are you? Are you talking about the actual characteristics of growth and value regardless of where they're housed? Are you talking about the indexes labeled growth and value? And if you are, you better understand what sits in those indexes because not all growth indexes and not all value indexes are created the same. Um, or are you thinking growth and value and preconceived notions? Oh, tech stocks are always growth stocks, and utility stocks are always value stocks. Well, there can be growth in value stocks. There can you can find value in growth stocks. So, I always think about growth and value based on the actual characteristics and I don't put blinders on in terms of just index labels.
>> So, what does growth look like right now?
>> So, you know, overall, sort of S&P 500 earnings growth looks great still. We had about, you know, depending on whether you're looking at, you know, FactSet numbers or or LSEG IBES uh numbers, call it, you know, 14%ish earnings growth for calendar year 2025 and actually a bit higher than that expected for calendar year 2026. Um, as I mentioned earlier, estimates for 2026 have actually been rising over the past month, which surprises a lot of people given all the uncertainty with regard to the war. But as I mentioned, it's mostly concentrated in upward revisions to the energy sector and the uh tech sector. I I think we're we're yet we still are going to get some downward revisions as analysts become a little bit more kind of fine-tooth comb as it when when we get to the end of the uh quarter. But maybe what's really important is that when we talk about how are earnings, how's growth, how's earnings growth, we often just hone in on the S&P 500, and that is the kind of a proxy for the economy, and it's obviously the the most dominant benchmark for for US equities, but it's 500 companies. What's maybe interesting, it helps to explain why there's sort of much more of a dour mood on the part of consumers, small business confidence being more dour than, you know, large company confidence is that if you look at all profits in the US, all US corporations, Fortune 500 companies, you know, sole proprietorships, S-corps, and by the way, you can track that via a a me a profitability metric that gets reported alongside GDP.
>> We don't yet have it for the fourth quarter because this particular metric, which I'll mention in one second, um, when we don't get for year-end until the final read on fourth quarter GDP, which will be next month, and then we'll get an update to what's called NIPA-based profits. NIPA is an acronym standing for National Income and Product Accounts. It's millions of companies tracked on a quarterly basis. Again, it is publicly traded companies, private companies, huge companies, tiny companies. It's the whole kitten kaboodle. Well, and we only have three quarters of data for it right now. So, we're we're not doing apples to apples here, but in the first two quarters of 2025, when S&P profits were up, you know, comfortably in double digits, um, NIPA-based profits were negative both quarters in a row. We had a mild pop up into positive territory in the third quarter. We don't yet know what the fourth quarter, but a tale of two very different sort of earning stories depending on whether you're talking about an index like the S&P, which is very large-cap growth-oriented companies, and corporate America.
>> So does that suggest that companies that aren't in the S&P 500 are not having an amazing time?
>> Oh, no, no, not necessarily. There's, look, there's tons of NASDAQ stocks that have done extraordinarily well. Um, you know, the the 10 best performing stocks in the NASDAQ last year, I I'd never heard of any of them. There's plenty of opportunity. The point is that you can't look at S&P 500 earnings and say that is the entire profile of corporate earnings in the United States. Um, that's not to say that the only game in town from a performance perspective, and that's another mistake that I think investors make is they think the only game in town is, you know, a cohort say like the Mag 7, certainly in years past when they were the biggest contributors to S&P returns. But here's here's some important numbers to to illustrate what I'm talking about here is last year, only two of the Magnificent 7 outperformed the S&P itself, and that was Alphabet and Nvidia. Alphabet actually was the the best performer among the Mag 7. It was the 75th best performer in the S&P 500. Nvidia was the number two best performer of the Magnificent 7. It was also the number one contributor to S&P returns, but it wasn't even in the top 80 of best performers. So, too many investors conflate contribution to index returns, which come partly as a result of the multiplier of your cap size. In a year like this, up until very recently, it's been working in the opposite direction because now we only have one of the Magnificent 7 outperforming the S&P. All the other stocks are underperforming to a meaningful degree, and now you're multiplying underperformance by a huge cap size. The real point of all of this, there's plenty of other fish in the sea. Individual investors that are not like a fund manager. They're not benchmarked to the S&P 500 on a quarterly basis. They're not at the mercy of the construction of these indexes. There's lots of fish in the sea, and there's lots of opportunity. And sometimes we get in this mindset of thinking the only way I can do well is to be in, you know, the Mag 7 or the mega-cap, uh, tech stocks. Um, there's there's plenty of other opportunities uh to do well, um, without taking that concentration risk.
>> So, 14% earnings growth is what's priced for the forward S&P?
>> No, it's actually closer to like 16 or 17 right now for 2026. 14 was about what calendar year '25 actual earnings were.
>> Yeah. Yeah. I know. Very high. And and and still historically high profit margins without much deterioration at all in forward estimates for profit margins. That I think is going to be the big sort of open-ended question that we'll all be asking during first quarter reporting season, which will start, you know, second week in April, is all right, can we can we rely on these lofty assumptions, or do we have to start adjusting our thinking about the ability to maintain historically high profit margins? What about the constituents of the, you know, whe the growth indices, whether it's S&P Growth or the Russell Growth, um, you know, just as in 2021, 2022, how some growth indices, which you think of, oh, they have tech stocks, actually had a lot of energy. I mean, do you think that the energy stocks will start to enter the growth indices just because that's where the earnings growth is?
>> Well, you know, it depends on how long-lasting the the move higher in oil prices are and the extrapolation length associated with higher earnings. Um, if you're just seeing analysts do, you know, a one or two quarter adjustment to estimates to reflect, you know, $100 Brent, $90 WTI, I don't think that's going to work its way into a massive rebalancing, say at the end of the year for S&P in favor of energy stocks to the same degree that existed back in that late 2021 period of time. But the longer we see oil prices elevated, when we already talked about the ripple effects into inflation, into monetary policy, into consumer spending, into profit margins, and to costs of things, etc., etc., then you could start to see analysts pricing in more longevity to that pick up in earnings for the energy sector. So, it, you know, it really does mean figuring out what the timing of this uh war is going to be. I'm not I'm not going to venture a guess.
>> And so you have a bullish view on the quality factor as we sit here right now?
>> Well, I I want to say bullish view on the quality factor. Quality is not sort of a singular factor. There are factor classifications that are really broad. Whether you might say quality, but I think of quality as a wrapper of a number of different factors. You know, higher return on equity versus lower return on equity, stronger balance sheet versus weaker balance sheet, either low debt or high interest coverage versus low interest coverage, you know, positive earnings revisions, trends, stability or or improvement in profit margins. I would put the quality wrapper around multiple factors.
>> And the and of those kind of many factors that contribute to the broad quality factor, the one that you are a bull on is high profitability.
>> Yeah, I I think profit, sort of visibility of profitability, not necessarily just, you know, find the stocks with the highest growth rate, but that that visibility, that stability in profit margins, uh, looking forward, I I think that is where an important factor focus should be.
>> And and if I were?
>> But also also balance sheet factors. I think in an environment now where the Fed has stepped back from easing policy, and there is now a a risk, valid or otherwise, that the Fed might have to consider hiking, that I think that's part of the reason why small caps have come under pressure very recently because a big part of the lift last year to small caps was when the Fed embarked on an easing campaign that lowers borrowing costs for smaller companies that tend to borrow via more traditional channels. They don't have as much access in the kind of private credit area. If you're pricing in an environment of kind of higher for longer, then things like interest coverage as a factor should be another area of focus.
Want to ask you about private credit in a moment, but if I were to ask you your views on the value factor and the momentum factor, both the broad, you know, sort of wrapper as well as the, you know, sub the contributors to the wrapper within, um, you know, obviously value has like price to book, price to earnings, but, you know, are are any of those things on which you have a a?
>> Well, so again, value is sort of a wrapper. I I actually think if I wanted to, um, sort of quantify with a word, the grouping of factors that I think makes sense right now, it would bring in an old-school uh acronym of GARP, growth at a reasonable price. I think this is an environment where you you don't want to look for growth but sacrifice value and vice versa. I think this is an environment where, as we already mentioned, you want to look for that that visibility in terms of profitability, stability, and profit margins without paying exorbitant multiples, whether it's, you know, peak multiples or or price to book. So that would be kind of that GARP-y growth at a reasonable price. As far as the momentum factor, you know, momentum again is more of a concept. Just if momentum as a factor is working, it means that the stocks that have been working continue to work. But there's different measurement lengths associated with momentum factor. So firms that do factor analysis and they they track factors that go to a more granular level will do different time horizons associated with factor like a one-month momentum, you know, a six-month momentum, a one-year momentum. So, I think momentum will probably work, but probably more the short-term momentum. You know, things that have been working for the last couple of weeks or maybe a month might continue to work. I'm not sure whether longer-term, call it one-year momentum type factors are what you want to focus on in this particularly unique period of high amounts of not just uncertainty but instability.
Thank you. You know, Liz, and I've been talking to some oil analysts, been reviewing other oilists' work. It seems to me like they have some pretty extreme concerns about the price of oil. Um, and I'm I'm sure you've been reading this work too. How do you interpret the quite quite dire analysis of, uh, you know, specialists in supply chains and oil just showing how, um, the current current uh, supply-demand imbalance is perhaps the, you know, the greatest in history. Uh, how much on the one hand is that a true concern versus on the other hand, so often in the history of investing, there are things that seem like they're a true crisis and actually that is, you know, a buying opportunity?
>> Right. I would say wouldn't surprise me if ultimately the answer is somewhere in between. I I I have tremendous sympathy for the higher-for-longer view on oil, even in an environment where you see de-escalation, whatever the heck that looks
like, in whatever form it would take and whenever that would happen. Because what we're talking about here is literally a choke point that doesn't have alternate routes through which 20% of all global oil supplies flows. There is no alternate route. That's very different from what we've seen in the past where you get, you know, a a quick supply disruption, a spike in prices, and supply chains can can kind of somewhat quickly adjust. That doesn't exist here.
It's in fact, it's the the only sort of oil and petroleum products as well as LNG choke point that doesn't have alternative routes. As a result of that, what's happened in light of very little traffic getting through is storage facilities filled up to the brim and as a result of those being filled, production got shut down. That is not something you turn back on very quickly.
um when you see how much the fertilizer industry is being hurt by virtue of this. If the straight opens back up, that doesn't help farms that haven't had the fertilizer they need. That takes time. So I that's why I think the this idea that when hostilities end that we'll see an immediate snapback to $60 oil that that story makes very little sense to me.
Um, you could see from maybe a trading perspective that might happen but it to me the more likely scenario and like you I pay a lot of attention to the experts in this area. I I'm not an oil expert. Um, so I also have to rely on energy experts and and I I think that this is this is quite unique. This is this is somewhat similar to the pandemic in terms of what it exposed as it relates to the lack of diversification in this in the supply chain. Obviously different beasts, the pandemic versus this, but it it represents an extreme in terms of supply dislocation that cannot be fixed quickly.
>> Do you think that this is going to cause increased volatility in the in the stock market? There's been increased tremendous realized volatility in the commodities market, the oil market, as well as implied volatility in the stock market. But, you know, the realized volatility in the S&P has been, you know, not not too too extreme, right? I think more likely we continue to see subsurface volatility um as witnessed through you know lots of rotation and churn under the surface. I I think that to me which has been the backdrop for the past and it's not just the past month you know this sort of I've been saying that the the momentum trade has become rotation like a lot of momentum traders that's what they're playing right now are these rapidfire rotations and trying to get you know kind of on the right side of these rotations. I think that's where we will experience continued volatility not necessarily picked up in those traditional broad market volatility uh measures.
>> Earlier you referenced private credits. Uh interestingly it's it's the not the borrowers of private credit that are experiencing you know some uh volatility in the markets but the actual lenders the companies that aggregate the the cash to raise the money and then and then deploy those to public as well as private vehicles. Could you summarize, you know, for our viewers how you you know, ju just the facts of of what has gone on over the past two months as as well as share share your your view?
>> Well, so really important essential caveat. This is not my baywick. I'm not a private credit analyst. I don't have expertise in private credit. That said, it has become a an obvious sort of touch point for the market, a cause of consternation, uh a cause for volatility and weakness even in the public markets among the stocks most directly tied to concerns about private credit. And and maybe I'm giving myself the ultimate wide birth here in saying that so far the disruptions that we have seen um some of the you know, the the defaults kicking in and concerns about um you know questionable lending practices and gates getting shut um liquidity concerns. the Jaime Diamond comment anytime he opens his mouth it's splashed all over the front pages maybe rightly so that you know once you see one cockroach and and we've seen more than just one cockroach we've seen now a handful of of cockroaches with some some failures and some serious concerns about lending quality and practices but I think we're shy of it looking akin to a 2008 systemic kind of takes the entire financial system down with it. You know, more than a couple of cockroaches to 2008 systemic crisis. The answer being somewhere in between. Yes, I'm giving myself an incredibly wide birth. I'd say what to watch would be traditional credit spreads which have started to increase but are not sort of screaming a dislocation that would be suggestive of a 2008 systemic kind of of crisis at least as of now.
>> Yes. I remember uh interviewing your colleague uh Kathy Jones, a specialist in fixed income and she struck a note of private to caution on on private credit. Um I I this is this was several years ago. Yeah, I wonder other analysts have have pointed out that you know high yield spreads h remain somewhat low even though they they've picked up but the sort of implied yield of private credit is so high and that there's a pretty pretty wide um dispersion there. So, so there's the there's the asset case of are these are these loans cockroaches? Are they going to cause trouble and then also the liability side of just people kind of with withdrawing their money and I think it is on people pulling their money that that is kind of what the center of
>> Yeah. but there's also you know there's also a little bit of a macro uh story here too as it relates to AI and uh the buildout associated with that. So, a couple of years ago, again, if you're going to just pick on the cohort that is the MAG 7 because everybody's familiar with what that represents and what stocks sit in there, you know, two years ago, free cash flow growth for the MAG 7 was running at more than 60% year-over-year. That's now in negative territory. More and more uh sort of capex is now being funded via debt deals, uh not just funded out of cash flows. So, that's a different dynamic that exists right now. uh and you see, you know, what became one of the poster children of concerns about too much debt being, you know, Oracle and the stock price getting hit and credit default swaps, you know, going through the roof. And I'm not an analyst of individual companies. I just mention it because it became sort of the poster child. I don't have an opinion on the on the stock, but um so I think it's that also broader AI, where are we in the AI buildout? Should we be at least as focused on what it's disrupting, but also how financing is being done, especially given concerns about the circularity of financing when that was financed out of earnings and strong cash flows, that was a different story than when more of the financing happens in the debt markets.
>> Yes. Again, not commenting on any individual company, but I think if a if like Facebook or you know, Meta doesn't pay back its private credit deal, the there's going to be so many problems in the world. You know what I mean? I I I I think also a lot of these private credit concerns is because a lot of these were direct loans to private equitybacked right um software companies and the software companies are going to be disrupted and in the public markets the software equities have absolutely plummeted like a stone and
>> until recently and then they they've had a pop which may not be all of a sudden the prospects for that industry improved but it got washed out and there was you know there was so much money that had moved move to the sell side, short side, and you get kind of a reversion to the the mean move. That isn't necessarily because all of a sudden the fundamental support case changed. It was probably never as dire as what the stocks reflected and maybe the move back up isn't fully reflective of some, you know, miraculous shift in the the outlook for for this group of companies. And you know, Lizenne, you um and your company, you sit at the intersection between a lot of institutional investors and retail investors. Private the the uh LPs, the investors in private credit funds historically have been extremely large pools of institutional capital. The the endowments, insurance companies, uh the charitable trusts and such. And you know, they are totally fine with having their money locked up for many many years. Increasingly, a lot of these alternative asset managers have raised money from uh through retail channels. also wealth managers and the like um wi with the similar gating type functions and you know I think it is good for stability that these gating things exist so that you don't have a kind of run on the bank
>> run on the bank yeah
>> yeah do do you think that this uh individual retail investors uh whether individually or or through a wealth manager do you think they will be able to um accept the the the lack of liquidity uh that
>> so that you know Harvard and Yale have historic That's an incredibly important question and the question that any adviser working with a client should be asking. The the most important component of this heightened interest on the part of individual investors and the further democratization of private markets and providing that access to individual investors is the education associated with it. That's certainly as a firm for the past, you know, 53 years been our belly wick is is making sure we are educating investors so that they understand how does whether it's private credit or private equity, how does it fit in your portfolio? How is it correlated to other asset classes in your portfolio? What is the time horizon associated? What is your risk tolerance? What is your need for income and liquidity? What is the willingness to give up some of that liquidity and in turn transparency? So all of those questions, they need to be seriously discussed with the investor who wants to embark on investments in the more opaque world that is private markets. Does the magnificent at 7 and I suppose I'm really asking about the hyperscalers that are investing uh hundreds of billions of dollars of capital to build out data centers and power AI do has their quality factor decreased because historically they were enormous cash generation machines very large cash from operations and that they were able to employ to you know dividends buybacks as well as just cash in the bank. now they're really spending money and and in some instances you know free cash flow is uh declining quite rapidly and forward estimates of free cash flow are perhaps negative. Um does does what do you say how that how that impacts the quality
>> again you know quality as an umbrella or specific quality factors. So, you know, free cash flow is a factor and that that's changed for many of the hyperscalers. They went from being massive free cash flow generators to less so at least in the aggregate. um you know but but other sort of quality growth oriented metrics you know the earnings trajectory is still fairly lofty and even valuation oriented factors to some degree have actually improved because you went through this period of underperformance while the earnings trajectory wasn't commensurately deteriorating such that you actually you know peeled off a few multiple points in the aggregate making the valuation piece look a little less concerning. So I I but but I don't want to I don't want to take it any further step from there because that's when you get into individual kind of companies which we do at Schwab. We have Schwab equity ratings. We rate 3,000 domestic stocks. We do a GPA. It's ABCDF. Um so anybody that has any interest can look up what you know is it an A-rated stock, a F-rated stock, or something in between. And so my analysis stops. Um it's even fairly uncommon for me to be talking in cohort terms of a group represented by only seven stocks. But it's you know it's an occupational necessity given the interest in in a cohort like that.
>> Lizanne I I believe before the war started a month ago international markets or non- US markets had been outperforming US markets.
>> Yep.
>> Did what did you think of that narrative. Did you buy that narrative before the war started? What do you think of that narrative now? You know, given the fact that obviously $100 oil, higher higher role than that, isn't going to help the US, but it is um a little more insulated than than other particularly emerging market countries that are in in Asian countries that are giant importers of of oil.
>> Yeah. Our our positive outlook for international markets actually dates back to October of 2022 when we came to the conclusion of that year's bare market in stocks. And as we started to see the recovery and a new bull market was starting, we very consistently expressed a view not dump all your domestic stocks and back up the truck and load up on nothing but you know MSEI EA and MSEM, but that this was a time you didn't want to shun international diversification. And so that was our view for the past couple of years. And more recently given what was and by the way up until the war began in Iran both Mseifa and AM were outperforming the S&P for the past 2 years. It wasn't just a very recent phenomenon but we always caveed with that doesn't mean again you get rid of your domestic exposure that international outperformance is not going to be linear. It's not going to be every week and every month and every quarter. Our message was more about don't shun international diversification more so than this is a no-brainer. International is going to consistently outperform domestic. That is still our view. But clearly there's been a shift back toward a domestic focus given the war and the disproportionate economic impact of higher oil prices and the closure of the straight of Hormuz has on non US markets. Not to mention the fact that we had been in a downward trend in the US dollar acrewing to the benefit in particular of emerging markets. Now throughout the course of the war so far we've been on an upward trajectory in the dollar not acrewing to the benefit of international relative to the US. How long the war lasts could help answer the question as to whether we continue to see that shift back to a domestic uh bias.
>> Lizen, I'm sure you you've seen the folks saying this. I'm curious what what's your reaction when analysts you make that table of 10 historical geopolitical uh uh you know uh um wars and uh five years later the returns were great. basically showing that the historical record shows that geopolitical uh chaos doesn't harm equity uh returns as much as people might feel at the time when it's
>> if it doesn't turn into protracted conflict that causes sustainably high oil prices that has a feeder into economic growth. That's always should always be a caveat. Yes. many of these sort of military conflicts that have been short-lived, even if they turn into longer data military conflicts like Russia, Ukraine, um if it's not sustainably high energy prices as a result of that feeding into recession risk going up, then they tend to have have a short-lived impact. I I think it's premature for us to say one way or another at this point. So, you know, give me give me a, you know, bring me somebody from the future to say how long this is going to last, how long oil prices stay high. I could more easily answer that question.
>> And needless to say, there's so much uncertainty about the war, the straight of hormuz. Is there anything you can say that you think is insightful that you actually have a a higher degree of of of confidence? People are trying to figure out what this looks most like in uh sort of past eras, whether it's military conflicts or where we are in the economic cycle, the combination thereof. I think this this does remind me a little bit of of kind of the 1990 period where we did see a spike in oil prices. We had Middle East conflicts. We had credit concerns that came as a result of the late 80s, you know, LBO boom and there there was, you know, the Greenspan at the Fed saying, "Nah, we really don't see this as having a big economic impact." Well, it it ended up having an economic impact. It didn't cause a serious recession, but it did have an economic impact. We did have close to a bare market in stocks. It again it wasn't didn't turn out to be a long extreme on the economic side or on the market side but in the early days of it it was dismissed as yet another geopolitical nothing to see here and you did end up having both economic dislocations and market dislocations not extreme not08 like but to me there are shades of of that 1990 period
>> right and you know I think that is remembered as kind of the uh quoteunquote good Iraq war when uh you know HW HW Bush quite quickly uh achieved his objectives had had a very uh he knew what he wanted to do and he achieved it quickly. Um I I think that would be you know quite a positive outcome. Uh I
>> we just you know we just don't really know what the objectives are uh uh this time. um and and um you know the the the decision if there is one to sort of pull back on the part of the United States anytime you're in an actual war in this case you know the three primary players um it's not a it's not a unilateral decision um so that's what makes this tricky as well
>> right and also Liz I feel like in the economy and markets there actually are a lot of self-correct mechanism. So for example, you know, normally if if commodity spikes, then producers come in to supply that commodity, the price goes down. The cure for high
>> whoever whoever said, you know, the the cure for high prices is high prices.
>> Right. Right. And you know, if there was a recession, then interest rates come down and that will stimulate growth. And so there's a lot of self-correcting mechanisms either, you know, natural to the market or through the government and central banks. No question. But it seems like in a war it's the opposite that uh bad things don't correct themselves and actually can lead to to more bad things.
>> Again it's sustainability here and and it's you know it's the straight it's literally that that straight of horses uh that is the key determinant here of what ultimately both the economic impact is going to be and related what the what the ongoing market impact is going to be.
>> We will leave it there. People can find you on X at Lizan Saunders and we will include your the link to to your work at Schwab. Thank you so much for coming on Lisan.
>> Oh, thanks for having me. Much appreciated.
>> I hope you enjoyed today's episode. Interested in learning more about the Pict AI enhanced international equity ETF ticker PQ NT or the Pict AI enhanced US equity ETF ticker PQUS. Click the link in the description to learn more. Until next time.
>> Thank you. Just close the door.