Sonders Says Deflation a Concern, but Double-Dip Unlikely

While saying that the market correction “may have legs”, Charles Schwab Chief Investment Strategist Liz Ann Sonders doesn’t expect a double-dip recession, and thinks a couple bullish signs have emerged for stocks.

“I believe we’ll see growth estimates pared back for the second half of this year and next year,” Sonders writes in her latest market commentary on Schwab’s site. “And the market’s correction may have legs. But the economy is now moving from recovery to expansion and they’re harder to stall. And, thanks to the correction, valuation has improved and excessively bullish sentiment is no more. The wall of worry is back — and that’s not a bad thing.”

Sonders also says one of her favorite market indicators —’s “Smart Money/Dumb Money Confidence Index” — is painting a nice picture, showing that the correction has “destroyed the excessive optimism of the dumb money that accompanied the market highs in April. At the same time, lower prices have enticed the smart money investors to up their bets for a market rally.”

As for the crisis in Europe, Sonders says it poses less of a threat to the U.S. and global economies than many believe.

“The real crisis is in the so-called PIIGS countries (Portugal, Italy, Ireland, Greece and Spain), collectively accounting for 35% of the European Union’s gross domestic product, but only 7.5% of global GDP,” she says. “The weak euro obviously brings some deflation pressure to the United States, but the direct impact on corporate earnings is not large. According to BCA Research, the exposure of all US corporate profits to the eurozone is about 9%. For the S&P 500, about 14% of operating earnings comes from the region. Assuming a 30% decline in the euro/dollar exchange rate, S&P 500 earnings would be shaved by only about 4%.”

Sonders also says deflation — not inflation — is a greater threat to the economy and markets right now, and notes that Schwab has had an underperform rating on materials stocks because of deflationary concerns. But, she adds, a double-dip recession isn’t likely. She says the yield curve, which “correctly called the past six recessions when it inverted (short rates higher than long rates)”, currently “sees the risk of a recession this year or next year as near zero.”

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