Of Mutual Interest Schwab strategist: Fed should begin raising rates

By Mark Jewell

AP Personal Finance Writer

BOSTON (AP) -- The chief investment strategist at Charles Schwab & Co. is bullish about the stock market over the long haul.

Yet Liz Ann Sonders worries the Federal Reserve has gone too far in trying to stimulate the economy. And she predicts the stock market is set to take a breather, after its more than 12 percent surge since the start of September.

One explanation for the gain: Investors expect the Fed next week to authorize another round of Treasury bond-buying to keep a still-shaky economy on track.

It's familiar terrain for Sonders. One of the reasons the 46-year-old has become an influential voice on Wall Street was her on-target prediction in September 2006 that the housing market was set for a hard fall.

At Schwab, Sonders guides market strategy for the San Francisco-based company with nearly $1.5 trillion in client assets, including nearly 8 million brokerage accounts.

She discussed her outlook in an interview at this week's Schwab Impact conference for investment advisers, held in Boston. Here are excerpts:

Q: How do you expect stocks to perform in the short run?

A: There are signs that we may be due for a bit of a pullback in the very short term.

The recent gains have at least partly or fully priced in expectations from two events next week: the midterm elections, and the steps the Fed is expected to take (at its two-day meeting, starting Tuesday).

I don't think it will be an extreme pullback. But you just establish a greater likelihood of disappointment after a rally, if there's a surprise and the expectations that led to the rally don't pan out.

But longer-term, third quarter earnings have been better than expected; the profit expectations for coming quarters have been quite good. Stock prices are still reasonable, and the economic news has been largely better, even in the housing market. Stack them together, and it's not a bad story.

Q: What segment of the stock market do you expect will be the leader in coming months?

A: Technology. Tech has been a leader so far in the market comeback, and that will continue.

Growth in the economy from 2003 to 2007 had very little to do with business capital spending, and everything to do with debt-fueled spending by consumers. So now we've got a tremendous amount of pent-up demand because of the dearth of business capital spending, and the moves companies have made to reduce debt.

Q: What do you think about the Fed's current policy of keeping interest rates near zero, where they've been for nearly two years now?

A: We're seeing the Fed operate on the patient as if it's still in triage. But I think the economy has come back to the point that the patient is in the recovery room.

Q: What course do you suggest?

A: Get back on a path toward normalizing monetary policy. Our company chairman, Chuck Schwab, wrote an opinion piece in the Wall Street Journal a couple weeks ago imploring the Fed to consider raising interest rates, and I have a lot of sympathy with that.

There are a lot of negative implications of zero percent interest rates in relative perpetuity. It's a disincentive for savers, who can barely earn anything on their investments. It's really hit the folks paying their mortgages, and doing the right things to save for retirement.

Zero percent interest rates as far as the eye can see just slow everything down. There's no rush by banks to lend, or for borrowers to borrow. The current policy says, "Rates are zero now, they'll be zero three months from now, and six months from now. What's the rush?"

Q: What outcome do you expect in Tuesday's midterm elections?

A: It's looking like House leadership will shift to the Republicans, and the Democratic majority in the Senate will narrow.

Q: If political gridlock sets in, how would that affect policy on financial markets?

A: It suggests there will be no major policy surprises in the next two years.

One aspect of financial regulation that won't be greatly affected by the election outcome is the rules that government agencies are writing to implement Dodd-Frank (the financial overhaul law approved in the summer). We're still early in the process of writing the rules.

Q: What about the election's impact on the Bush era tax cuts, and whether they will be extended beyond this year? President Obama and most Democrats want to extend the cuts for every family making less than $250,000, but let them expire for the wealthiest households.

A: It's becoming clear that dozens of Democratic members of Congress will oppose the president, and join Republicans in supporting a full extension, even for the top bracket.

There were a lot of people sitting down with their tax planners earlier in the year when people believed almost definitively that they could expect taxes to rise. That is certainly less definitive now.

Q: Do you think the cuts for any of the brackets will go away in the foreseeable future?

A: We could see Congress extend the cuts for the top income bracket for only another year, then let them expire, while the cuts for the lower brackets continue.

Published: Mon, Nov 1, 2010

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