Schwab Intelligent Portfolios October 4, 2019

    Key Themes

    • U.S. stock market returns remained positive in Q3 but continued to moderate amid growing concerns about trade frictions and slowing global economic growth.
    • Diversification benefited investors as both equity and fixed-income markets remained volatile as recession fears increased and the Fed cut rates for the first time since 2008.
    • Despite the market volatility, most portfolios across the risk spectrum delivered moderately positive returns for Q3 and strong returns YTD.

    How did financial markets do in Q3 2019?

    The third quarter of 2019 saw modest gains for the U.S. stock market amid continued volatility on mixed economic signals and heightened geopolitical risks. Slowing global economic growth, weakness in manufacturing and continued trade friction ramped up concerns about recession risk. However, U.S. economic growth remained solid, supported by healthy consumer spending and steady U.S. job growth. While U.S. stocks have gained more than 20% YTD, most of that came in the first-quarter rebound following the correction in late 2018. Notably, over the past year since the end of September 2018, U.S. stocks have moved relatively sideways and are up a more modest 3%, with some big up and down moves along the way.

    Fixed income markets also saw volatility in Q3 as interest rates fell sharply in August in anticipation of Fed rate cuts amid the growing economic concerns. The Fed made two quarter-point cuts in its first rate cuts since 2008. However, it described them as a mid-cycle adjustment rather than the start of an extended easing cycle, leaving the future direction of short-term interest rates uncertain. Following the Fed’s cuts, longer-term rates moved higher again in September, though the yield curve remained relatively flat and has moved in and out of inversion throughout the year, with longer-term rates below short-term rates at times.

    For the quarter overall, interest-rate sensitive and defensive investments such REITs and gold were the top-performing asset classes amid the interest-rate moves and elevated uncertainties. Corporate bonds and other fixed income asset classes also were among the leaders. International investments continued to be weighed down by global economic concerns as well as currency movement as the US dollar strengthened a bit during the quarter. For the YTD and longer-term 3-year periods, all asset classes delivered positive returns.

    Figure 1: Market Performance (Ranked by Q3 2019 total return)
    Index Total Returns (%)
    Asset class Q3 2019 YTD 2019 3-Year (Annualized)
    U.S. real estate investment trusts (REITs) 7.5 25.4 6.9
    Gold & other precious metals 4.4 13.6 2.1
    Investment-grade corporate bonds 3.0 13.2 4.5
    U.S. large cap stocks 1.7 20.6 13.4
    U.S. Treasuries 1.3 6.0 2.0
    High-yield bonds 1.2 12.2 5.9
    Emerging markets bonds -0.6 5.3 2.4
    International large cap stocks -1.1 12.8 6.5
    U.S. small cap stocks -2.4 14.2 8.2
    Emerging markets stocks -4.2 5.9 6.0

    Source: Morningstar Direct, as of September 30, 2019. Performance figures shown are total returns for each asset class during the designated period. Indexes used are: U.S. real estate investment trusts, S&P United States REIT Index; Gold and other precious metals, S&P GSCI Precious Metals Index; Investment-grade corporate bonds, Bloomberg Barclays U.S. Corporate Investment Grade Index; U.S. large cap stocks, S&P 500® Index; U.S. Treasuries, Bloomberg Barclays U.S. Treasury 3-7 Year Bond Index; High-yield bonds, Bloomberg Barclays High Yield Very Liquid Index; Emerging markets bonds, Bloomberg Barclays Emerging Markets Local Currency Government Bond Index; International developed market large cap stocks, MSCI EAFE Index; U.S. small cap stocks, Russell 2000® Index; Emerging markets stocks, MSCI Emerging Markets Index. Past performance does not guarantee future results. Indexes are unmanaged and cannot be invested in directly.

    Style leadership shifts from "Growth" to "Value"

    A notable shift in performance leadership among investment styles occurred in September, with "value" leading after an extended period of "growth" leadership in recent years. High-flying tech stocks that had powered market indexes higher in recent years pulled back while sectors that had been pressured, such as financials and energy, showed improvement. Schwab Intelligent Portfolios invests in both investment styles by including two forms of indexing for additional diversification within the five major equity asset classes: traditional market cap indexing and Fundamental indexing.2

    Market cap indexing weights companies by market capitalization and has an inherent "growth" tilt, while Fundamental indexing tends to have a "value" tilt and weights companies in the index by fundamental measures of company size such as sales, cash flow and dividends. Each of these forms of index investing tends to lead in different market environments, so including both within a portfolio can enhance diversification while retaining the benefits of indexing such as low costs, transparency and tax efficiency. Whether the shift to "value" leadership that occurred in September marks the beginning of a sustained style shift in coming quarters remains to be seen, but it came as a welcome tailwind for Fundamental indexing.

    How did Schwab Intelligent Portfolios do?

    During Q3, most portfolios across the risk spectrum delivered positive performance, with more conservative portfolios modestly stronger than more aggressive portfolios amid the market volatility. However, portfolio returns were relatively flat across the risk spectrum as major equity and fixed income asset classes saw less differentiation in performance than typical. Over the longer-term, more aggressive portfolios have delivered higher long-term returns but those gains have come with greater fluctuation in returns, both to the upside and downside. By contrast, more conservative portfolios have delivered more moderate gains but with greater stability.

    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 recommended to invest 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 Q4 2019

    Moving into the final months of the year, economic signals remain mixed and geopolitical risks remain elevated. Slowing global economic growth, weakness in manufacturing and continued trade frictions have raised concerns. A fractious political environment in the U.S. as well as increasing Mideast tensions focused on Iran have led to additional uncertainties. In the U.S., corporate earnings growth has been weak in recent quarters, while consumer spending, the labor market and housing have continued to support solid overall economic growth.

    While recession risks have risen, credit markets and overall financial conditions do not appear to be signaling that a contraction is imminent. However, market volatility is likely to remain elevated amid the uncertainties and shifting direction of trade talks with China. At the same time, market valuations remain near their long-term averages in the U.S. and below long-term averages in international markets.

    As markets continue to digest incoming data, it's important to stay focused on your long-term goals and what you can control rather than over-reacting to short-term market fluctuations and letting emotions drive decision-making. Taking a disciplined approach based on time-tested investing principles such as keeping costs low, investing in a diversified portfolio, rebalancing and ignoring short-term market noise are among the keys to long-term investment success.

    How Schwab Intelligent Portfolios Can Help

    With up to 20 asset classes in any single portfolio, and automated rebalancing, tax-loss harvesting and goal tracking, Schwab Intelligent Portfolios is designed to recommend a diversified portfolio consistent with your risk profile and manage your portfolio with discipline to help keep you on track toward reaching your financial goals.

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

    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 markets stocks. For more information on Fundamental Indexing, see https://intelligent.schwab.com/public/intelligent/blog/fundamentally-weighted-etfs.html


    Please read the Schwab Intelligent Portfolios Solutions™ disclosure brochures for important information, pricing, and disclosures related to the Schwab Intelligent Portfolios and Schwab Intelligent Portfolios Premium programs.

    Schwab Intelligent Portfolios® and Schwab Intelligent Portfolios Premium™ are made available through Charles Schwab & Co. Inc. ("Schwab"), a dually registered investment advisor and broker dealer.

    Schwab Intelligent Portfolios® and Schwab Intelligent Portfolios Premium™ are designed to monitor portfolios on a daily basis and will also automatically rebalance as needed to keep the portfolio consistent with the client's selected risk profile. Trading may not take place daily.

    Diversification, automatic investing and rebalancing strategies do not ensure a profit and do not protect against losses.

    Tax‐loss harvesting is available for clients with invested assets of $50,000 or more in their account. Clients must choose to activate this feature.

    (1019-949J)


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