#75 - Liz Ann Sonders: Investing Principles, Inflation, Instability, Diversification

0:05Welcome to the Insightful Investor Podcast, a weekly series that seeks to share industry, investment, investment, and market insights. We define insights as concepts that are counterintuitive, widely misunderstood, or underappreciated. In other words, unique ideas that you probably won't hear elsewhere. I'm Alex Shahidi, the host of the podcast and co-CIO of Evoke Advisors, a leading investment advisory firm. Learn more about our show at insightfulinvestor.org.

0:38Today's guest is Lizanne Saunders. Lizanne is the longtime chief investment strategist at Charles Schwab. She's responsible for market and economic analysis and investor education for the firm's 34 million accounts and probably rising by the day. Lizanne has been at Schwab for over 25 years and is a regular guest on CNBC, Bloomberg, CNN, CBS News, and other business news networks. Welcome, Lizanne. Oh, thanks for having me, Alex. Much appreciated. And just to timestamp this, we're recording this podcast on June 10th, 2025. Lizanne, the first principles of investing are often considered to be, one, maintain a long-term discipline, two, be diversified, and three, avoid all the behavioral missteps.

1:30These are simple in theory, but challenging in practice, as you know. But what are your thoughts on why this is so difficult for most investors? Because it's our money and we have emotional attachment to our money. And it tends to, I think, exacerbate those natural emotions of fear and greed, which tend to infiltrate investment decision making. And, you know, ideally, what investors can do is not figure out the hard way, whether there is a wide or narrow gap between what we could think of as financial risk tolerance. What's on paper? We sit down with an advisor. We map out a long-term strategy.

2:12It involves your financial risk tolerance. But then there's the emotional risk tolerance. And unfortunately, a lot of investors learn the hard way that there's a pretty yawning gap between those two. And it is those classic emotions of fear and greed. And it's why those tried and true disciplines, you mentioned diversification, such a key one. And then periodic rebalancing, which forces us to go against those emotions. It forces us to essentially do a version of buy low, sell high. It's add low, trim high. Of course, often when left to our own devices, we do the opposite. And that's where those emotions of fear and greed tend to come in.

2:51It's so interesting because when you describe it that way, buy low, sell high, everybody would agree that's a good investment strategy. Yet our emotions force us to do the opposite of we buy high and we sell low. We buy the things that have done well, and we want to sell the things that have done poorly. Why do you think that is, even though it's illogical and obviously illogical? And I don't even know so much that it's that we continue to buy. Yes, there is a lot of that momentum chasing, you know, lots of acronyms, including, you know, FOMO. But I think it's just as importantly, the decision not to trim back the emotion of why wouldn't I just let my winners run?

3:33And putting maybe in the back of your mind the potential peril of having overly concentrated positions and not letting that rebalancing work in your favor. I think it's just human nature. And I always say to investors, it's not what we know that matters, meaning about the future, what the market's going to do, what a particular stock is going to do, picking tops and bottoms, that's inherently unknowable. It's what we do along the way that matters, not what we know, meaning about the future. So I think sometimes we just have to think in real world terms about how emotions play trick with us. I have such a great story, and it's a short one.

4:16I was out in Silicon Valley area less than a year ago, and I was having a conversation with a client who had a very concentrated position, maybe no surprise, and NVIDIA. And he was very lovely, wasn't angry, but said, I'm a little frustrated. My Schwab financial consultant kept trying to tell me that I should maybe pare back about 10 % of my position. They were going to do it in a tax-friendly way. I fought back on it. I ended up trimming 5 % of the position, and then the stock quickly went up 20%. So I'm kind of mad. And I thought, would you, and I said to him, would you have been happier if the 95 % you still owned went down 20 %?

4:59And to his credit, he paused. He said, I guess that's the way I should think about it. So that's just an example of how those emotions tend to play tricks with us. It is very interesting in that there's also this aspect of investing where hindsight, we've heard hindsight is 20-20. but it's interesting how people look back and they say, I knew that was going to happen. And then they conveniently forget the things that they thought were going to happen that didn't. And so you get this selective memory and you become overconfident in your ability to predict. And that kind of feeds into all of this as well.

5:34Correct. So I talked about the kind of the three core principles, long-term investment, investing, diversify and avoid the behavioral missteps. Are there any other core principles you believe investors should embrace? Well, I think maybe I phrase it in terms of one of the mistakes that investors make, and it has to do with the connectivity between time horizon and risk tolerance. And I think too often investors think that there's a direct link between your time horizon and your risk tolerance. Meaning if you're young, you're automatically a risk tolerant investor and you should take a more aggressive stance, vice versa, if you're on the older end of the spectrum.

6:16But actual tolerance for risk is more than just about time horizon. You can be a 30-year-old investor and still have a long time horizon before, say, retirement. But if at the first 10 % or 15 % drop in your portfolio, that fear factor is going to kick in and you panic and sell, I don't care how long your time horizon is, you are not a risk-tolerant investor. I had the great pleasure many, many years ago, somewhat obviously, of meeting the late, great Sir John Templeton. And he was in his early 90s when I met him, and he talked about still being a fairly aggressive investor at that age. It obviously was not because he had a long time horizon ahead of him, but he understood the risks and he was willing to take risk.

7:02He was also a billionaire, so maybe that's a factor too. So I think that's another area we need to focus on is those real tenants of risk tolerance and the questions you need to ask yourself. And those questions need to go beyond just how many years do I have between now and retirement? Yeah, I guess that's one factor. But what the factor that really matters is what your actual time horizon is for the investment that you're making. And if you're prone to selling when you get a downturn, and people always forget the downturns associated with really bad news and a bad outlook. So if you're prone to that, then your time horizon is much shorter than what the math would suggest.

7:43And that's what you have to be honest with yourself about. And you have to kind of look back and ask yourself, how did I react the last time something bad happened? And have an honest assessment of what your actual time horizon is. Absolutely. And I think also understanding the connectivity between what's going on in the real world in the economy and what's going on in the market, and understanding that there is a connection there, but the timing is off and off. And also understanding that, and I've been saying this for my nearly 40 years in this business, we as humans tend to think in absolute terms.

8:17Was it good or was it bad? Was it strong or was it weak? Now I'm talking specifically about a piece of economic data. When, as it relates to how markets behave, more often than not, better or worse matters more than good or bad. Yet it's human nature for us to think in good or bad terms, but it's that rate of change. It's that direction of travel that often matters even more than the level of whatever it is the data is showing. There's one other aspect and it's related a little bit to what we talked about earlier, which is everywhere outside of the investment world, past returns are indicative of future results.

8:51If you have an underperforming employee, they'll probably be underperforming in the future. If you have something that's working in the past, it'll probably work in the future. Investing, oftentimes it's the opposite. The better something did in the past, it's basically borrowing future returns today and it may underperform in the future. And so it's easy to be sucked into chasing returns in the world of investing because that discipline is reinforced everywhere outside of investing. But going against that grain is very difficult from an emotional perspective. And that is what can trip investors up.

9:28But that's a very good point. Let's move into kind of the outlook and news. You know, many investors focus on short-term news and are vulnerable to major economic shifts, some of these major inflection points. Do you believe we are at a significant economic inflection points today? I think we definitely were in the beginning of April. Had those reciprocal tariffs that were announced on April 2nd gone into effect, and we don't know ultimately what happens at the end of what was the subsequent 90-day delay that was announced, I think it was a massive inflection point in the economy because we were talking about at that time an average effective tariff rate of somewhere in the mid to high 20 % range up from less than 3 % pre-inauguration day, that would have represented an epic change, well beyond even what we saw during the Smoot-Hawley days of the Great Depression.

10:26That said, where we are right now is a 15 % average effective tariff rate, five times bigger than where we were before. So I think that there is a little bit of complacency, maybe because of what I actually said before, which is better or worse matters more than good or bad, and things are better. But I do still think that we are at a potential inflection point here. And some of it is just the natural inflection point of going through cycles and recessions haven't been outlawed. We will get one again. But I still think we could be at a trade war related inflection point, not to mention something even more existential, bigger picture, if there's a continuation of trying to truly reorder the world from a global trade perspective, which we have an incredibly complicated global ecosystem of trade.

11:22And trying to unwind that in short order, I think brings with it some volatility that in many cases we've already seen, but I think could still very much be ahead of us. Let's stay zoomed out for a little bit. So until recently, we've enjoyed low and stable inflation for decades. Do you expect inflation volatility to rise in the coming years? Yes. And I'm glad you asked the question that way, Alex, because if you had said, do you expect high and sustainable inflation on a forward-looking basis, my answer would have been no, but inflation volatility. So the period from the mid-1990s up until the early part of the pandemic, often referred to as the Great Moderation Era, to your point, was characterized by limited inflation volatility.

12:11As a result, less monetary policy volatility, less overall economic volatility. We also had the massive wave in that era of globalization that really kicked into high gear in 2001 when China joined the World Trade Organization. We also had the energy boom in the United States, courtesy of fracking and shale, moving the United States to be energy independent. All of those forces conspired to provide that backdrop of a fairly benign inflation environment, somewhat benign monetary policy environment, leaving aside, obviously, the global financial crisis. And I think most of those ships, quite frankly, have sailed.

12:53And I think the environment we're arguably already in, if not in the process of transitioning into may look a bit more like the period from the mid-60s to the mid-90s, where you had more inflation volatility. Again, that's not the same thing as saying high inflation for an extended period of time, but we certainly saw in the 1970s a tremendous amount of inflation volatility. I don't think that's what we're facing because that was in large part due to monetary policy mistakes of hanging the victory banner, easing policy only to see inflation let out of the bag again than having to scramble and tighten policy.

13:30That happened three times in the 70s, ultimately leading to Paul Volcker having to come in and pull a Paul Volcker and ramp up interest rates, bring on back-to-back recessions in order to really finally break the back of inflation. But I think with this deglobalization or regionalization or just-in-case versus just-in-time, whatever terminology you want to use, not to mention geopolitics and demographics, I think means we're probably in a more volatile inflation backdrop, which again leads to potentially more volatility in monetary policy, maybe even fiscal policy, probably shorter economic cycles.

14:08The good news about the period from the mid-60s to the mid-90s is that the up parts of the cycle from an economic growth perspective were actually stronger than during the Great Moderation. So it is an all doom and gloom with that comparison. And are there any other specific investment implications if we do experience inflation volatility? Yeah, potentially important ones. So for almost the entire, call it 25-year period of the great moderation, bond yields and stock prices moved in the same direction. And that's because we had a benign inflation backdrop. So as a, for instance, in that era, when bond yields were going up, it was typically reflective of growth improving.

14:50Without the attendant concern about a big inflation problem, stronger growth without an inflation problem is sort of nirvana for equities. and vice versa. When yields were coming down, it was reflecting weakening growth, potential recession, negative for the equity market. Well, rewind back to that 30-year period from the mid-60s to the mid-90s. Nearly that entire period, the relationship between bond yields and stock prices was the opposite. In that era, because inflation was sort of the bugger, when yields were going up, it was often reflecting one of those sort of up cycles in that volatile period of inflation, not necessarily attended stronger growth, much more negative for the equity market and vice versa.

15:34Recently, we've been kind of bouncing in and out of positive and negative correlation territory. And I think the near-term reasons why you tend to bounce around is if inflation is keying, I mean, if yields are keying off inflation, you tend to see that negative relationship, higher yields, lower stock prices. If inflation settles down, there's less inflation volatility and yields become a little more connected to the growth outlook, higher yields, higher stocks reflecting the growth outlook. So I think understanding that relationship in the short term requires the why behind what bond yields are doing.

16:17So I don't think the period that we're in is going to look exactly like the mid 60s to the mid 90s, lots of other differences, but maybe that more volatile inflation backdrop could be a cornerstone of the next secular era. And that also feeds into how one should think about diversification, because for that great moderation period in the 90s until recently, stocks and bonds were good diversifiers for the reasons that you described, because inflation was relatively low and stable and growth was moving around. And those are good diversifiers in different growth environments. But if you have both growth and inflation volatile and uncertain and unpredictable, then you probably have to think about diversification beyond just traditional stocks and bonds.

17:00Yes and no. You're right in that very simple relationship between bond yields and stock prices does change the calculus around diversification. But what it may suggest, maybe even more so on the fixed income side of things than on the equity side of things, is a more targeted approach, maybe a little bit more of an active approach and or just holding fixed income securities to maturity so that you're not as subject to the price swings. And you're basically banking on earning the yield over time. So there are strategies that can be employed, not to mention the fact that the availability of asset classes other than, you know, simple stock exposure, simple bond exposure, even for smaller individual investors is such that the diversification story can span beyond just your generic 60-40.

18:00And that allows for the ability to find diversifiers that move outside of that very simplistic asset allocation structure. One of the terms that's probably overused today is uncertainty. There was always some level of uncertainty in markets, but do you think that the risk of extreme outcomes is higher today than usual? Yeah. So you and I were chatting before the cameras went on and I think you're right. I always chuckle in my own mind when I hear the market hates uncertainty. I don't know, have you ever woken up to a Wall Street Journal article that said there's nothing, everything is certain right now.

18:38We know everything. There's always uncertainty. I think maybe the better descriptor for the current environment is unstable, which has just a slightly different meaning. And when we think, therefore, about tail risks, yeah, I think the tails are a bit wider than they have been in the past. Unfortunately, I think that left tail risk, which is the potential negative outcome might be a little more fat, as they call it, than the right-tail risk. I think we're living sort of in a right-tail risk of that things in relative terms as opposed to absolute terms. You go from, you know, reciprocal tariffs on every single country and an average effective tariff rate of close to 30 percent in Armageddon scene and global economies to, okay, not as bad as we thought it was going to be.

19:32But I think we can't dismiss, notwithstanding how strong the market has been, and maybe an example yet again of the market likes to climb a wall of worry, but I do worry that there is some complacency that might have kicked in with regard to economic outcomes, inflation outcomes, the reaction function on the part of central banks, this unique period of certainly during the early April carnage of seeing the equity market down at the same time bond prices were down because yields were going up and the dollar down. That is somewhat unprecedented activity across those three asset classes in the United States.

20:15Not atypical to see that in emerging markets. It is in the United States. And that probably, that combination, I think was the trigger to get the administration to deescalate. So I do think market forces might continue to be that message on, okay, we need to pull back a little bit here. That said, I'm not going to try to get in the mind of the policymakers here. It's mercurial to say the least. Well, trade wars and tariffs have so far had limited inflationary effects. You just touched on that. Was the initial concern overstated or are we still early? I think we're probably still early. If you look at the latest CPI and PPI data, so consumer price index and producer price index, and we get the next reading on those, I think it's this week.

21:13But the prior reading that we have in the books, the reference period that that covered encapsulated an average effective tariff rate of less than 5 % versus the 3 % where we were pre the initiation of the trade war. So we don't have a lot of the data actually in the numbers yet. Now it will start to be reflected in the data. That said, inflation measures cover more than just the prices of goods that are being impacted by tariffs. And that's going to be the interesting, I think, necessity of looking at inflation data is having that fine tooth comb. So when we get it as a for instance, the CPI data, there's a very heavy component of CPI that is the what we call the broadly the shelter components, inclusive of owners equivalent rent.

22:08there's actually pretty significant downward pressure in those categories versus likely upward pressure on goods-oriented categories that are directly impacted by tariffs. So I think we're going to have to do a lot of parsing when we get this data to truly see the impact, not to mention that it's probably going to take some time for it to really filter through. We are hearing from most companies that they're going to try to pass on a decent amount of these costs. And by the way, I've gotten into a habit, Alex, of just throwing out the actual definition of tariffs. And the reason why I've been doing it is I've been surprised at how many times when I do it, people come up to me afterwards and say, I didn't quite know that that's how tariffs work.

22:53So notwithstanding the headlines of tariffs on China, tariffs on Canada, or even as recently as yesterday or today, I heard President Trump saying, we should have been charging China all along what we're charging them now, and they're now paying us more in tariffs. Well, that's not how tariffs work. Tariffs are paid by the U.S. company importing the goods from China or the European Union or Canada or Mexico, whoever the targeted country is. So it's a tax on U.S. companies. A valid debate is who ultimately bears the cost at the end of the proverbial day. One thing that does not happen is the targeted country doesn't tend to cut their costs in order to offset the tariff that the U.S.

23:37company pays. So then it's a question of U.S. company pays it. Do they eat it in their profit margins? Do they try to pass it on to the consumer? The latter is what tends to happen. But we're just at the stage of companies trying to navigate that, figuring out what can stick. We know they built up inventories by front running the tariffs, and they built up inventories at a fairly low cost basis. So there is a lot of experimentation right now. You're even hearing from some companies saying, we plan to raise prices not just on goods that have tariffs attached to them, but in general in order to protect our profit margins.

24:14So there's going to be a lot of data that we're going to have to parse through in the next few months to get an accurate sense of this. But I think it's too soon to just look at the recent inflation data and say nothing to see here. It was all overblown. I think there's still a lot more impact still ahead of us. That's helpful perspective. Thank you. So obviously, we live in a world of heightened economic policy and geopolitical, I won't say uncertainty, but instability. How should investors think about portfolio construction given that backdrop? Carefully. But I think this is really where discipline comes into play.

24:52It is hard enough in any market environment to try to time things. So the all or nothing get in, get out strategy, we would never recommend, even in the most certain of times, as if there is such a thing. But in particular, given, as we've seen over the past few months, that knee-jerk extreme moves we can see in the market off of literally a social media post tells you that you want to step back. If anything, you want to reinforce a longer-term time horizon, not think in shorter time horizons. Reinforce those disciplines of not just diversification in general, but across asset classes and within asset classes.

25:35having that periodic rebalancing approach. Frankly, it's the stuff that if I go on CNBC, if you bring on a guest on your podcast, the more boring stuff to talk about. If CNBC is having one of their markets in turmoil, 7 p.m. specials, they're unlikely to want to hear me talk about the beautiful disciplines of diversification across and within asset classes and rebalancing, they're going to typically ask somebody like me, okay, Lizanne, are you telling your investors to get in or get out? Well, those are just gambling on two moments in time, and that doesn't tend to work out. So I think if anything, this type of chaotic backdrop should really reinforce those long-term disciplines.

26:22I wish it was more bombastic or fine-tuned or it's just, that's the way you need to approach it. You know, more specifically, stay up in quality. Understand that now it looks like international diversification is paying some dividends. That was a harder sell. So take advantage of some of the market, some of the voices coming out of the market in terms of reinforcing some of those disciplines around, Be careful about not allowing positions to get concentrated and be mindful that the benefits of diversification can sometimes show up really quickly. The other point that I would add, and I'm curious if you agree to maintaining that long-term discipline and being diversified and all those things, is that when you have more news around the uncertainty and the instability, you're also more likely to react and your emotions may be bubbling at the surface and could cause you to have those behavioral missteps.

27:25Absolutely. And more often than not, as the news on the economic front, on the geopolitical front, whatever it is, the non-market specific news, as it becomes more heightened, you tend to see volatility and weakness in the market. but it also ends up with the benefit of hindsight, you get that aha. It ended up being an interesting opportunity that was represented an inflection point of sorts for the market. Not necessarily a message to try to time that, but understanding that when it comes to even something as specific as there's a number of different policy uncertainty indexes out there. Bloomberg has several that they track.

28:12They're sometimes global in nature or domestic in nature. It might be specific to just trade policy or more broadly economic policy uncertainty. And interestingly, market performance following extremes in those types of uncertainty indexes have actually been pretty strong because the market prices a lot of that uncertainty and that risk in and therefore provides an opportunity. So if you're purely reacting emotionally, especially if your attitude is, I'm just going to get out until things calm down, until the skies are clear again, you've probably missed some of that inflection point that naturally comes at times where it feels most uncomfortable.

28:56How do you evaluate major stock market cycles? And where do you think we are in the current cycle, particularly in the US? Well, there's lots of ways to think about market cycles, but I must say here, I'm going to invoke Sir John Templeton again with probably the most famous thing he ever said about markets, which is bull markets are born on pessimism. They grow on skepticism, mature on optimism, and die on euphoria. And I think that's such a brilliant way to think about a full market cycle, in part because it's exclusive of anything related to what we think of as driving markets. There's nothing in that line, so to speak, about valuations or sentiment.