Liz Ann Sonders, senior vice president and chief investment strategist at Charles Schwab, struck a hopeful tone on the US economy in a media briefing yesterday, due to the stabilisation of significant economic indicators.

Noting certain risks, such as the possibility some asset classes are overheating, “stratospheric” debt levels in the private and public sector, and the “horrendous” outlook on budget deficits, Ms Sonders nevertheless is optimistic about prospects for investors and the wider economy.

The market rallies seen in the second and third quarter of this year have caused alarm in some people, as they haven’t been accompanied by comparable improvements in indicators on the real economy.

Unemployment, which remains stubbornly high, is often cited as a barrier to an economic recovery, hindering the revival of consumer demand and confidence. However Ms Sonders pointed out that it is a lagging indicator, and a decrease in unemployment would follow rather than lead the revival. Initial claims are declining, which is a better indicator of where the economy is heading said Ms Sonders.

The non-farm payroll declined by 1.3 basis points more in 2009 than predicted by the fall in real GDP based on historical trends. Ms Sonders said this was because, in terms of employment, “some companies didn’t just cut to the bone, but into it”. If this interpretation is correct, there will be a catch up phase in employment as business confidence returns.

Ms Sonders used the analogy of coiled springs to describe the behaviour of inventories, production and employment: the downward pressure on which was so severe that they should bounce back strongly. 

Ms Sonders believes the trend in equities is generally upwards, although the strong rally is unlikely to repeat itself for some time, and was a bounce back from the extremely sharp knock the markets took in 2008. However the current bull market is above the historical norm (measured as a historical bull market composite), which could mean more corrective phases, Ms Sonders said.

She was most optimistic about the technology sector saying it represented “the innovation that makes the recovery more long-lasting”, and has had it on an outperform rating for some time. Meanwhile Charles Schwab recently downgraded materials and industrials to market perform, and upgraded consumer staples and telecommunications to neutral.

Ms Sonders believes there has been a bias towards bonds as investors have moved out of cash, with bonds outperforming stocks in terms of the 20-year trailing return. When this situation occurred in the past, stocks strongly outperformed bonds in the proceeding five years. Therefore Ms Sonders thinks investors may miss out on these gains if they remain biased towards fixed income.

Ms Sonders did refer to a US dollar-funded carry trade, and the possibility certain asset classes, such as gold and emerging markets, were overheating, a concern that recently prompted the release of an IMF report.

When questioned about when she thought the Fed would raise rates, Ms Sonders said she thought it would be sooner than expected, and that she hoped it would be in a position to raise them next year, as a situation where the Fed couldn’t move for an extended period of time was a much gloomier prospect than a rate raise prompted by an improvement in conditions.