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‘There’s no question there are a lot of micro-bubbles:’ Charles Schwab SVP

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Yahoo Finance’s Alexis Christoforous and Liz Ann Sonders, Charles Schwab Senior Vice President and Chief Investment Strategist, discuss market moves as the short-squeeze continues.

Video Transcript

ALEXIS CHRISTOFOROUS: I want to stay with the markets now and bring in Liz Ann Sonders. She is senior vice president and chief investment strategist at Charles Schwab. Liz Ann, always good to see you. It's been a while. And boy, we have a lot to talk--

LIZ ANN SONDERS: Thank you, nice to be here.

ALEXIS CHRISTOFOROUS: We have a lot to talk about. As a Wall Street professional, as you see what's been unfolding with GameStop, with AMC, today with silver and some of the activity we're seeing in biotech, what would your message be to the average investor watching all of this unfold?

LIZ ANN SONDERS: Well, for one thing, I think it's really important in an environment like this, especially over the last week or two, to differentiate and educate with regard to the difference between speculating and investing-- two entirely different things. And I think a lot of the moves that we're seeing in some of these individual stocks, heavily shorted stocks, nonprofitable tech companies, penny stocks, now out into the commodity sphere, is pure speculation. It's not driven off of fundamentals.

That doesn't mean it can't be profitable for some period of time. But it does make me think of games maybe a lot of us played when we were younger, whether it's pin the tail on the donkey or musical chairs. And, you know, I fear that it doesn't end well in many cases for some of the holders.

But I also think we've seen a morphing in the past week, where it's hard to really differentiate or segment out what portion of this are retail day traders and what portion of it are quants and algos and other hedge funds that, either by virtue of their quant methodology, kind of taps into wherever the momentum is, or they want to sort of play the retail crowd at their own game.

But, you know, so far, the good news is unlike, say, 1999, 2000, the most heightened speculative activity is not in the big major stocks driving the S&P 500. So maybe that's one saving grace.

ALEXIS CHRISTOFOROUS: You know, I think you're right that we could probably look at some of these individual stocks and say those are stock stories. Like, you look at GameStop, right? Up 400%, 500% in a week. That's sort of undeniably a bubble. But when you look at the broader market, Liz Ann, are you seeing a little too much frothiness there? I mean, you-- are some of these stocks just getting too far away from their fundamentals? And are you concerned about that?

LIZ ANN SONDERS: So I would certainly apply the term bubble to a lot of areas that we've already touched on. So there's no question there's a lot of microbubbles. I'm not sure we're quite yet there in terms of the broad overall market. There are frothy sentiment conditions, even in traditional sentiment metrics. Certainly things like fund flows, recent ETF flows, you're seeing it in other behavioral measures, certainly in the options market, with an incredibly low put call ratio.

You know, in terms of valuations, I think the one important difference between now and, say, circa '99, 2000, is that we know heading into what were excessive valuations. Then, it was a function of stock prices and earnings going up. It's just prices were going up faster than earnings. We know with the benefit of hindsight that earnings were rising into a peak and falling down.

What caused, at least initially, the spike in the PE ratio in this environment was the collapse in earnings driven by COVID and the fact that we're now on an accelerating path for earnings. And so far, anyway, what we're getting in the fourth quarter signals that 2021's estimates may be too low. I think the action of the denominator, meaning E, is, so far anyway, probably the most important differentiator between now and 2000, even if there are still excesses that may need to correct a bit.

ALEXIS CHRISTOFOROUS: So, to your mind, high valuations don't necessarily mean that the end of the rally is near. Do you think that we have further to go and that the market is going to continue to climb higher here in Q1?

LIZ ANN SONDERS: I mean, the honest answer is, I don't know. I think we often think of valuations as this quantifiable fundamental indicator, which it is. You've got the quantifiable denominator and numerator. The problem is that valuation can sometimes be ignored or really end up becoming an indicator of sentiment. Not so much a sentiment indicator, but an indicator of sentiment.

And I think a lot of the money that's most aggressively in the market on the buy side in this environment isn't doing it based on some unique explanation for lofty valuations. So I don't think this has really been a valuation story in terms of why we've seen the momentum that we have. As to how long we can go on, we all remember Greenspan's irrational exuberance comment, which was at the end of '96. And we still had 3 and 1/4 years left of the bull market.

So I don't know how long this momentum kind of frenzy continues, other than at least we have the good news of an accelerating E in front of us, which was not the case back in 2000.

ALEXIS CHRISTOFOROUS: So you're thinking that perhaps these high valuations are rooted in something a little more fundamental, shall we say? The fact that--

LIZ ANN SONDERS: No, not-- no, that's not what I'm saying. I'm just saying that given where we are right now, if we have to-- if you are a fundamentalist and you're looking at valuations, yes, you get the bulls that will justify valuations based on very low level of interest rates. So that discount rate has basically been promised by the Fed to stay low. So on equity risk premium type valuation analysis, you can argue the market isn't as expensive.

I'm just saying that I just don't think valuation has been a dominant factor driving the market. I don't think that's-- it's not that most of the momentum-driven investors are simply finding a way to justify valuation. They just have put it aside as a factor they're not focused on. It's very momentum-driven right now. And that can last for an extended period of time.

I'm just saying if you are a fundamentalist, and you're not one to say, OK, let's use equity risk premium instead of PE ratio, at least looking ahead, if you're wondering, OK, is there any hope for improvement in lofty valuations, the hope is that estimates may actually have to continue to go up for 2021. So those fundamentalists at least can rest to some degree on the direction of the E.

ALEXIS CHRISTOFOROUS: You mentioned the Fed. How much do you think the Fed is going to play into market sentiment this year? I mean, the latest FOMC meeting, we saw Powell come out again and basically say they're going to keep rates low for long, even if inflation starts to creep up. So how much is the Fed really a part of the conversation this year?

LIZ ANN SONDERS: I think, staying relatively easy, what their policy is, is a given and an expectation the consensus. And I think where a potential risk comes into play, especially if we maintain these incredibly elevated, sort of sentiment environment, and speculation continues to be rampant, I think a potential catalyst for maybe a difficult period in the market is, is, as we get through the vaccine period of time, and we see the economy open back up, if we start to see some signs of inflation more than just supply-demand imbalance-driven price shocks.

And there's a concern that starts to build that either the Fed's getting behind the curve, or they may have to start to telegraph a tapering at some point-- probably less on the rate side, more on the balance sheet side-- the question is, what is the stomach that the market has for dealing with that, especially if it is in an environment where that sentiment level is still sort of in the highly complacent, excessive optimism territory. So I would put that near the top of my list of risks that we might need to contend with this year.

ALEXIS CHRISTOFOROUS: All right, we're going to leave it there. Liz Ann Sonders of Charles Schwab, always good to see you. Thanks so much.

LIZ ANN SONDERS: My pleasure.