Performance | Thursday, October 13, 2022

Schwab Intelligent Portfolios & Q3 2022 Market Performance¹

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Key Points

  • Markets started Q3 with a rally over optimism for a potential Fed pivot that quickly shifted to recession fears and another market slide to new lows for 2022. 

  • Diversification within equities helped moderate overall portfolio declines as asset classes such as U.S. small cap stocks were among the top performers during Q3; however, stocks remained deep in negative territory YTD.

  • Bonds mostly declined during Q3 due to the continued headwind of rising interest rates; however, diversification helped as fixed income asset classes such as high-yield bonds and intermediate-term Treasuries held up better than the aggregate bond index.

  • Cash remained the best performing asset class YTD, highlighting why it's an important part of a diversified portfolio in helping provide ballast in turbulent times.

  • For Schwab Intelligent Portfolios, the pressure on both stocks and bonds resulted in negative returns in Q3 and YTD, though diversification helped moderate overall portfolio declines.

How did financial markets do in Q3 2022?

The third quarter of 2022 saw a rapid shift in investor sentiment to accompany the shifting seasons. The quarter started with optimism that the Federal Reserve might slow its pace of rate hikes as inflation showed signs of moderating and begin to cut rates in early 2023. However, that optimism quickly faded as inflation remained stubbornly high and shifted to concerns that the Fed's inflation fighting efforts could potentially tip the economy into a recession.

The rapid shift in sentiment during Q3 was evident in the U.S. equity market, which saw a nearly mirror-image shift mid-quarter. The quarter started with a rally for the S&P 500® Index that peaked in mid-August before grinding down to where it began the quarter. It then tumbled to new lows for 2022 following the Fed's third-consecutive 0.75% rate hike near quarter-end. Small cap stocks held up better and were among the top performers during Q3, underscoring the benefits of diversification, while international stocks were among the bottom performers due to the headwind of a rapidly strengthening U.S. dollar.

Bonds also saw sizable declines in Q3 as long-term interest rates took a similar round-trip, moving lower during the first half of Q3 and then rising to end the quarter above their Q2 highs. Shorter-term interest rates moved steadily higher as the Fed continued its rapid pace of rate hikes and exceeded long rates, a phenomenon known as an inverted yield curve that has historically tended to precede recessions. Interest rates in general have moved significantly higher from where they started the year, with most bond asset classes also deep in negative territory YTD. However, diversification has paid off as asset classes such as intermediate-term Treasuries and TIPS have held up better than the aggregate bond index. Cash remained the top performing asset class so far in 2022, underscoring why it's an important part of a well-diversified portfolio.

Other economic signals were mixed. While inflation remained at historically high levels, components such as gasoline prices came down significantly from their Q2 highs. Unemployment edged higher but remained near historical lows. Corporate earnings were mostly solid, with a few notable weak spots, though expectations for profits in coming quarters moved lower. And the housing market slowed further as mortgage rates surged to their highest levels since 2008.

Figure 1: Market performance (ranked by Q3 2022 total return)

  Index Total Returns (%)
Asset class Q3 2022 1-Year 3-Year
High-yield bonds -0.9 -14.9 -1.4
U.S. small cap stocks -2.2 -23.5 4.3
Municipal bonds -3.5 -11.5 -1.8
U.S. Treasuries -3.8 -11.3 -2.2
U.S. large cap stocks -4.9 -15.5 8.2
Investment-grade corporate bonds -4.9 -17.9 -3.6
Emerging markets bonds -5.0 -13.2 -2.3
Treasury Inflation Protected Securities (TIPS) -5.1 -11.6 0.8
Securitized bonds -5.2 -13.8 -3.5
Gold & other precious metals -8.0 -4.1 4.0
International large cap stocks -9.4 -25.1 -1.8
International small cap stocks -9.8 -32.1 -2.2
U.S. real estate investment trusts (REITs) -10.0 -16.4 -1.9
Emerging markets stocks -11.6 -28.1 -2.1

Source: Morningstar Direct, as of Sept 30, 2022. Performance figures shown are total returns for each asset class during the designated period. Indexes used are: High-yield bonds, Bloomberg High Yield Very Liquid Index; U.S. small cap stocks, Russell 2000® Index; Municipal bonds, Bloomberg Municipal Index; U.S. Treasuries, Bloomberg U.S. Treasury 3-7 Year Bond Index; U.S. large cap stocks, S&P 500® Index; Investment-grade corporate bonds, Bloomberg U.S. Credit Index; Emerging markets bonds, Bloomberg Emerging Markets Local Currency Government Bond Index; Treasury Inflation Protected Securities, Bloomberg TIPS Index; Securitized Bonds, Bloomberg Securitized Index; Gold and other precious metals, LBMA Gold Price PM; International developed market Large cap stocks, MSCI EAFE Index; International developed market small cap stocks, MSCI EAFE Small Cap Index; U.S. real estate investment trusts, S&P United States REIT Index; Emerging markets stocks, MSCI Emerging Markets Index. Past performance does not guarantee future results. Indexes are unmanaged and cannot be invested in directly.

How did Schwab Intelligent Portfolios do?

For Schwab Intelligent Portfolios, the renewed volatility of the markets in Q3 resulted in negative returns for the quarter. Conservative portfolios generally saw modest declines due to the pressure on bonds during the quarter. Moderate portfolios saw moderate declines that varied based on their combination of stocks and bonds. And Growth portfolios saw larger declines after stocks tumbled following the Fed's rate hike near-quarter end.

While returns were negative across the risk spectrum during a volatile quarter and YTD, diversification within Schwab Intelligent Portfolios to include fundamental index ETFs and defensive asset classes such as Treasuries and cash helped moderate overall portfolio declines.

Looking ahead to Q4 2022

Moving into the final quarter of 2022, take a moment to look back at previous periods of volatility. Market turbulence inevitably occurs from time to time. It's not unexpected when the Fed is tightening financial conditions and investors are grappling with assessing the economic trajectory and future earnings growth of individual companies. Historically, however, markets have eventually found their footing and have recovered, which is why it's so important to stay focused on your longer-term goals when markets become volatile rather than succumbing to emotions.

These periods of turbulence have historically highlighted the importance of focusing on what you can control and adhering to time-tested investment principles, such as those used by Schwab Intelligent Portfolios, of diversification, periodic rebalancing and sticking with your longer-term plan. These are among the keys to long-term investment success.

David Koenig CFA®, FRM®, is Vice President and Chief Investment Strategist for Schwab Intelligent Portfolios