Liz Ann Sonders: Navigating a New ‘Temperamental Era’ in Markets

Episode Summary

Executive Summary: Lizanne Saunders argued the post-pandemic economy is moving out of the long ‘Great Moderation’ into a more volatile ‘temperamental era’ marked by higher inflation volatility, more supply shocks, shorter cycles, and stronger emphasis on fundamentals. She sees recessionary weakness already in goods, possible spillover to services, tighter credit after SVB, and more attractive conditions for active, factor-based investing as rates stay higher and price discovery returns.

Main Topics: End of the Great Moderation / start of a ‘temperamental era’ (Priority: 5/5): Saunders defines the Great Moderation as the late-1990s-to-pandemic period of globalization, disinflation, and stable cross-asset relationships. She argues the world is shifting toward more inflation, geopolitical, and economic volatility, with supply chains regionalizing and central banks unlikely to return to zero/negative rates soon. Recession assessment and rolling recession (Priority: 5/5): She says parts of the economy are already in recession territory, especially goods, housing-related activity, and factories, while services had been holding up. The cycle looks like a rolling recession rather than a single broad collapse, with the NBER likely to confirm a recession only later. Inflation, CPI vs. PCE, and Fed policy (Priority: 5/5): Saunders explains why headline inflation can fall while core remains sticky, emphasizing volatile energy effects and the lagged shelter component in CPI. She argues the Fed is trying to avoid repeating the Arthur Burns mistake of declaring victory too early and then having to re-tighten. Bond market, valuations, and market regime change (Priority: 4/5): She highlights the unusual disconnect between the Fed, bond market, and equities, and says the return of the risk-free rate is restoring price discovery. That makes fundamentals more relevant, weakens the case for passive-only approaches, and changes valuation dynamics. Credit tightening, SVB, and small-bank stress (Priority: 4/5): Post-SVB, she expects tighter lending conditions, especially for small and regional banks with commercial real estate exposure. She views the damage as a grind rather than a single crisis event, with impacts likely to show up in bank lending, bankruptcies, and business investment. Housing, affordability, and recession signals (Priority: 3/5): She says housing affordability was hit by all three legs of the stool—prices, incomes, and mortgage rates—but prices have not fallen much because supply remains tight. Housing may be stabilizing, but its behavior around the Fed’s pause could indicate whether the economy is landing softly or rolling over again. Portfolio implications: active management, factors, and non-U.S. exposure (Priority: 4/5): Saunders favors active management and factor-based investing over rigid style boxes or pure passive exposure, especially as correlations shift and inflation/rate volatility rises. She also sees benefits in developed international diversification, though she remains less enthusiastic on EM given geopolitical uncertainty.

Key Arguments: The ‘Great Moderation’ was sustained by abundant goods, energy, and labor supply, but globalization, shale, and China’s integration into trade made that environment unusual and probably temporary. A more volatile macro regime should mean more frequent but shorter cycles, not necessarily worse investing outcomes—just different ones, with more opportunity for active managers and fundamentals. Recession is better understood through leading indicators and sector breadth than the unemployment rate, which is highly lagging and often still low at recession start. The current downturn is ‘rolling’: goods and housing have already weakened, while services held up longer due to a stronger, less interest-sensitive labor market. Headline inflation can improve because energy falls, while core remains sticky because shelter dominates core CPI and lags real-time housing conditions. The Fed is more likely to hold rates higher for longer than rush into cuts; cutting too early would risk repeating the Burns-era policy mistake. Credit conditions were already recessionary before SVB, and the banking shock will likely tighten lending further, especially for smaller and regional banks. The return of a positive risk-free rate reduces the old era of ‘capital misallocation’ and should improve price discovery, helping active managers and factor investing. Valuation should be judged relative to the bond market and earnings direction; the market often does best when earnings are stabilizing or bottoming rather than surging. Investor diversification should include more attention to developed non-U.S. markets because regionalization and geopolitics may weaken the dollar’s dominance marginally over time.

Data Points: Great Moderation period: Late 1990s to the pandemic - Used by Saunders to define the prior low-volatility, disinflationary regime Economic regime prior to Great Moderation: Late 60s to late 90s - Historical comparison for Saunders’ ‘temperamental era’ idea NBER recession indicators: Payrolls, industrial production, personal income, business sales - Measures Saunders cites for dating recessions Claims increase from trough: 30% to 35% - She says unemployment claims have risen this much from their low Average claims lift before recessions: 20% - Historical comparison used to argue recession risk is elevated Unemployment rate at recession start: Typically near its low - Used to argue the unemployment rate is a lagging indicator CPI core shelter weight: 43% of core CPI - She emphasizes how shelter distorts core inflation readings Mega-cap tech names in SP pure growth before rebalancing: 8 of 8 - Apple, Microsoft, Alphabet, Amazon, Meta, Tesla, Nvidia, etc. were in the index before December rebalancing SP pure growth tech weight before rebalancing: 37% - Tech share of SP pure growth before the December reshuffle SP pure growth tech weight after rebalancing: 13% to 14% - Tech exposure fell sharply after the December rebalance Russell 1000 growth tech weight: 42% - Illustrates index construction differences in growth exposure Home sales decline: About 40% peak-to-trough - Combined existing and new home sales decline this cycle Home price decline in this cycle: Only a couple percent - Shows prices held up despite a housing recession in sales Commercial real estate exposure: About 80% of CRE lending by small/regional banks - Explains why stress may hit smaller lenders hardest Excess savings estimate: About $1 trillion - She says this could be largely exhausted by the second half of the year SVB-related timing in quarterly bank data: Only two weeks of trouble included - Why first-quarter quarterly data understated the full banking impact 2011 debt-ceiling precedent: S&P debt downgrade and 18%–19% S&P fall - Used to warn about risks from another brinkmanship episode S&P earnings yield vs. 3-month Treasury yield: Recently went negative for the first time since 2001 - A valuation signal Saunders says is bearish for stocks Inflation peak referenced: 40-year high - Used to explain why the Fed’s job is harder now Bear market vs. recession timing: Bear markets often begin at or just before recessions - Her framework for why market lows may not align neatly with NBER dating

Pivotal Quotes: "I think we're in that transition, which means you're going to see a lot of choppiness and not necessarily concrete signs that this is happening." — Lizanne Saunders: On moving from the Great Moderation into a more volatile macro regime "We're in recession territory pre-SVB, it's probably going to start to hit services and the labor market." — Lizanne Saunders: On her view that parts of the economy were already weakening before the banking stress "The return of the risk-free rate, which means the era of the absence of price discovery and the era of capital misallocation, hopefully, is in the rear view." — Lizanne Saunders: On the market implications of higher rates and tighter financial conditions

Implications: Investors should expect more volatility, more differentiated performance across sectors and assets, and greater value in active, factor-aware portfolios. The cycle favors selectivity, not broad beta, and recession/credit developments may create both risks and opportunities.