Performance April 7, 2017

    Key Themes

    • Global diversification boosted performance as international investments were the strongest performers during Q1, led by emerging markets.
    • The S&P 500® Index of U.S. large-cap stocks posted its strongest quarter since 2015 as the bull market celebrated its eighth anniversary.
    • Market-cap indexing took the lead after fundamental indexing's lead in 2016, illustrating why Schwab Intelligent Portfolios® includes both forms of indexing.
    • All portfolios across the risk spectrum delivered positive returns during Q1 2017.

    How did financial markets do in Q1 2017?

    Global financial markets across geographies and asset classes delivered strong returns for investors during Q1 amid signs of improving global growth, despite the many geopolitical and economic uncertainties that remain. Schwab Intelligent Portfolios investors who took a globally diversified approach likely benefited as international investments were the strongest performers, helped by the tailwind of a slightly weaker U.S. dollar so far in 2017. Emerging market stocks led the charts with a gain of more than 11%, their strongest quarter since 2012. International developed markets delivered their strongest quarter since 2013.

    While the S&P 500 didn't keep up with international stocks, it still gained more than 6% in its best quarter since 2015. That stands in stark contrast with the first quarter of 2016, which saw a market correction of more than 10% amid a global growth scare. After surging more than 13% since the November presidential election to a new high on March 1, the U.S. stock rally stalled in the final month of the quarter as health care legislation failed and it appeared that expected tax and regulatory reform might take longer than investors had anticipated.

    Following an extended period of below-average volatility, the end of the quarter also brought the first daily decline of at least 1% for the S&P 500 in 109 trading days. This brief bout of turbulence served as an important reminder for investors not to be lulled into complacency by the recent gains and relatively smooth ride. Markets are volatile by nature and most years tend to see a significant pullback at some point. Having the discipline to navigate through these inevitable periods of turbulence while sticking with your financial plan is one of the keys to long-term investment success.

    Figure 1: Market performance (ranked by Q1 2017 total return)
    Total returns (%)
    Asset class Jan Feb Mar Q1 2016
    Emerging market stocks 5.5 3.1 2.5 11.4 11.2
    Gold & other precious metals 5.5 3.7 -0.5 8.9 8.4
    International small-cap stocks 3.2 2.2 2.0 8.0 2.2
    International large-cap stocks 2.9 1.4 2.8 7.2 1.0
    Emerging market debt 2.9 2.2 1.6 6.8 5.9
    U.S. large-cap stocks 1.9 4.0 0.1 6.0 12.0
    U.S. small-cap stocks 0.4 1.9 0.1 2.5 21.3
    International bonds 1.9 0.3 0.3 2.5 1.5
    High-yield bonds 1.2 1.4 -0.3 2.4 16.6
    Investment-grade corporate bonds 0.3 1.2 -0.2 1.2 6.1
    U.S. real-estate investment trusts (REITs) -0.3 3.7 -2.7 0.6 8.5
    Treasury bonds 0.3 0.3 0.1 0.6 1.3

    Source: Morningstar Direct, as of March 31, 2017. Performance figures shown are total returns for each asset class during the designated period. See disclosures for indexes used. Past performance does not guarantee future results. Indexes are unmanaged and cannot be invested in directly.

    Bonds advance despite Fed rate hikes

    Bonds also delivered positive returns during Q1 despite Fed rate hikes in December and March. Among U.S. bonds, high-yield and investment-grade corporate bonds were the strongest performers, though they each saw small declines in March. Treasuries eked out small gains for the quarter. While the Fed appears to remain on track for additional rate hikes in 2017, bonds rallied following the March hike after the Fed reiterated that its pace of increases will remain gradual. Despite the potential for higher interest rates going forward, it's important to remember that bonds can still play an important role in a diversified portfolio in delivering income and helping to moderate stock market volatility.

    Market-cap indexing leads so far in 2017

    After significantly outperforming market-cap indexing in 2016, fundamental indexing took a breather during Q1. Market-cap indexing led by between approximately 0.5 and 2.3 percentage points across the five major equity asset classes, as shown in Figure 2. This shift in performance leadership illustrates why we believe that combining both fundamental and market-cap indexing in a portfolio helps provide additional diversification.2 Each of these forms of index investing tends to lead in different market environments, so including both within a portfolio adds diversification while retaining the benefits of index investing such as transparency, tax efficiency and low costs.

    Fundamental indexing helped improve portfolio returns YTD

    How did Schwab Intelligent Portfolios do?

    All portfolios across the risk spectrum delivered positive returns for Q1 2017. As would be expected in a period of strong equity market performance, the most aggressive portfolios were the strongest performers due to their larger allocations to stocks. More conservative portfolios saw more moderate gains due to their larger allocations to bonds, while also delivering their intended lower volatility.

    Knowing which type of portfolio is most appropriate for you is a matter of understanding your goals and risk tolerance. Schwab Intelligent Portfolios is designed to recommend a portfolio consistent with your objective, time horizon, and ability and willingness to take risk. Whether you're invested in a more conservative or more aggressive portfolio is based on your answers to our online Investor Profile Questionnaire. We recommend that you revisit the questionnaire at least annually to ensure that your portfolio continues to be suitable based on your current goal, time horizon and risk tolerance.

    Looking ahead to Q2 2017

    Heading into the second quarter of 2017, Schwab's view continues to be that the bull market remains intact after celebrating its eighth anniversary in early March. Corporate earnings growth is showing signs of strengthening following a soft patch in 2016, unemployment remains low, and business and consumer confidence is strong. Recession risk appears to remain relatively low, although plenty of uncertainties remain around geopolitical risks, the pace of Fed rate hikes, rising inflation, trade policy and a range of other issues.

    These uncertainties are likely to result in periods of turbulence throughout the coming year. As demonstrated in 2016, investing in a diversified portfolio based on your goals and risk tolerance can help you navigate through these inevitable periods of volatility while staying focused on your longer-term financial plan.

    1. This quarterly commentary is designed to provide you with insight into the market environment during the quarter. How your portfolio performed is dependent upon your asset allocation across the risk spectrum from conservative to aggressive, as well as criteria such as when you opened your account, the timing of any deposits/withdrawals, timing of portfolio rebalances, whether you are enrolled in tax-loss harvesting and other criteria.

    2. As an additional layer of diversification, Schwab Intelligent Portfolios splits the allocation between a market-cap weighted ETF and a fundamentally-weighted ETF for the five major equity asset classes: U.S. large-cap stocks, U.S. small-cap stocks, international large-cap stocks, international small-cap stocks and emerging market stocks. For more information on fundamental indexing, read our blog post.

    Indexes used in Figure 1 are: emerging market stocks, MSCI Emerging Markets Index; gold & other precious metals, S&P GSCI Precious Metals Index; international small-cap stocks, MSCI EAFE Small Cap Index; international large-cap stocks, MSCI EAFE Index; emerging market debt, Bloomberg Barclays Emerging Markets Local Currency Government Bond Index; U.S. large-cap stocks, S&P 500® Index; U.S. small-cap stocks, Russell 2000® Index; international bonds, Bloomberg Barclays Global Aggregate ex-USD Bond Index; high-yield bonds, Bloomberg Barclays High Yield Very Liquid Index; investment-grade corporate bonds, Bloomberg Barclays U.S. Corporate Investment Grade Index; U.S. real estate investment trusts, S&P United States REIT Index; U.S. Treasuries, Bloomberg Barclays U.S. Treasury 3-7 Year Bond Index.

    Indexes used in Figure 2 are: U.S. large-cap stocks, Russell Fundamental U.S. Large Company Index vs. S&P 500® Index; U.S. small-cap stocks, Russell Fundamental U.S. Small Company Index vs. Russell 2000® Index; international large-cap stocks, Russell Fundamental Developed ex-U.S. Large Company Index vs. MSCI EAFE Index; international small-cap stocks, Russell Fundamental Developed ex-U.S. Small Company Index vs. MSCI EAFE Small Cap Index; emerging market stocks, Russell Fundamental Emerging Markets Large Company Index vs. MSCI Emerging Markets Index.

    (0717-78DJ)


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