Here's what Charles Schwab's Liz Ann Sonders has to say about the economy, her favorite book, and investing in a recession

Happy Saturday, readers. I'm senior reporter Phil Rosen. I've just finished teeing up your weekend reads — and there are some doozies on deck.

Today's newsletter features my conversation with Liz Ann Sonders of Charles Schwab, and why she thinks the economy's already in a recession.

Then, we'll dig into some of the best reads from across Insider's award-winning newsroom.

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Liz Ann Sonders is the chief investment strategist at Charles Schwab. This conversation has been lightly edited for length and clarity.

Phil Rosen: Can you explain your "rolling recession" assessment of the US economy?

Liz Ann Sonders: Typically when you go into a recession, everything's sort of hit all at once. That was certainly the case with the COVID recession and financial crisis.

But now, specific categories have gone into recession territory, like housing, consumer confidence, CEO confidence, or metrics like the inverted yield curve. But you have that offsetting positive, because of the pent-up demand that's still finding its way into services and keeping the labor market afloat.

Eventually you'll see a rolling over there, in part because that's precisely what the Fed's trying to do, weaken the labor market such that inflation continues to decelerate. I think it's only a matter of time before many of the segments not yet hit, do get hit — a situation where weakness rolls through.

How deep do you expect the downturn to get?

LAS: Some pockets have been hit, you've seen pretty deep contractions. But overall I would expect that we can avoid a major deterioration in GDP, because of the rolling nature, but also because we don't have the kind of imbalances that we did in the 2007 to 2009 period.

When the housing bust happened, it took the entire global financial system down. But there's none of that now, so it should keep GDP contractions limited, barring some black swan event. But it might last a longer time because of the rolling nature.

How do you see the Fed navigating the coming months?

LAS: The Fed's trying to perfectly thread the needle of weakening the labor market, trying to crush job openings without crushing employment. That's always tricky. Either they overshoot, and you have a more severe contraction in the economy, or they declare victory too soon on the inflation front.

Because we haven't seen significant enough loosening in the labor market, you have a kind of 1970s-type story. But conditions surrounding today's inflation are quite different from the '70s. What really caused Volcker in the 1980s to have to "pull a Volcker" and hike rates was because of the mistake in the '70s — when the Fed thought inflation was tackled, they loosened policy, it reignited again.

So the Fed wants to avoid the fits and starts that ended up leading Volcker to do what he did. They want the medicine to be applied with more consistency.

Near-term pain in the labor market sets up a better long-term economic outlook.

How will stock market investing change in 2023?

LAS: There's important shifts that started this year that will continue next year, and one is that fundamentals have gotten reconnected to prices. Equal weight [stocks] are doing much better relative to cap weight; active managers are having a much better year than has been the case in the past. A lot of this has to do with the fact there's actually a risk-free rate again.

Investors should focus on "what's missing," in the macro sense. In other words, for example, we're in a declining earnings revisions environment, meaning forward earnings estimates are coming down, you then want to look for companies that have positive earnings surprises.

We're not in an environment where making a sector call or two is going to be the way to do well. It's going to be more based on fundamentals, and I think that's actually a positive backdrop, even if we're still in an environment where volatility is likely to persist, because what I think is not yet priced into the market is the further deterioration in earnings.

Can you share a book recommendation?

LAS: I have my absolute favorite book of all time, "Reminiscences of a Stock Operator." That was the first book given to me when I started in this business in 1986, and it's the one I recommend all the time.

It really helps people understand how psychology comes into play as a more important driver of what markets do than any other fundamentals.

And your favorite quote about markets?

LAS: It's what I think John Templeton is most known for: "Bull markets are born on pessimism, grown on skepticism, mature on optimism, and die on euphoria."

Read the full interview with Liz Ann Sonders here.

What did you think of Sonders' insights?

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Curated by Phil Rosen in New York. Feedback or tips? Tweet @philrosenn or email prosen@insider.com

Edited by Max Adams (@maxradams) in New York.