Schwab Intelligent Portfolios January 13, 2020

    Key Themes

    • U.S. stocks surged higher in Q4, ending the year with their strongest gains since 2013.
    • Diversification benefited investors as performance leadership shifted to international asset classes, small cap stocks and "value" investing in the final months of 2019.
    • With strong performance across asset classes in 2019, portfolios across the risk spectrum performed as expected and delivered strong returns for the year.

    How did financial markets do in Q4 2019?

    Financial markets raced to new highs in the final days of 2019, echoing the powerful rally that kicked off the year. The S&P 500® Index of U.S. large cap stocks surged more than 31% in its strongest year since 2013. Those strong gains left investors ringing in the New Year in a far more jovial spirit than in 2018, when markets ended the year with a sharp correction. Markets remained moderately volatile throughout 2019, but overcame continued trade and political uncertainties as corporate earnings remained solid and the Federal Reserve shifted from interest rate hikes to a series of rate cuts.

    For the fourth quarter, international investments took the lead. Asset classes such as emerging market stocks and international small cap stocks shifted from the bottom of the performance rankings in Q3 to the top in Q4, reminding investors of the importance of diversification as different investments constantly move up and down the leader board. Emerging markets was also the leader among fixed income investments while Treasuries were slightly negative for the quarter. For the YTD and longer-term 3-year periods, all asset classes delivered positive annualized returns.

    Figure 1: Market Performance (Ranked by Q4 2019 total return)
    Index Total returns (%)
    Asset class Q4 2019 2019 3-Year
    (Annualized)
    International small cap stocks 14.7 25.0 10.9
    Emerging markets stocks 14.0 18.4 11.6
    U.S. small cap stocks 12.2 25.2 8.6
    International large cap stocks 11.3 22.0 9.6
    U.S. large cap stocks 11.1 31.5 15.3
    Emerging markets bonds 4.5 9.5 6.5
    High-yield bonds 3.0 15.3 6.3
    U.S. real estate investment trusts (REITs) 2.0 24.4 7.7
    Investment-grade corporate bonds 0.5 14.5 5.9
    Gold & other precious metals -0.5 17.6 8.3
    U.S. Treasuries -0.7 5.9 2.9

    Source: Morningstar Direct, as of December 31, 2019. Performance figures shown are total returns for each asset class during the designated period. Indexes used are: International developed market small cap stocks, MSCI EAFE Small Cap Index; Emerging markets stocks, MSCI Emerging Markets Index; U.S. small cap stocks, Russell 2000® Index; International developed market large cap stocks, MSCI EAFE Index; U.S. large cap stocks, S&P 500® Index; Emerging market bonds, Bloomberg Barclays Emerging Markets Local Currency Government Bond Index; High-yield bonds, Bloomberg Barclays High Yield Very Liquid Index; U.S. real estate investment trusts, S&P United States REIT Index; Investment-grade corporate bonds, Bloomberg Barclays U.S. Corporate Investment Grade Index; Gold and other precious metals, S&P GSCI Precious Metals Index; U.S. Treasuries, Bloomberg Barclays U.S. Treasury 3-7 Year Bond Index. Past performance does not guarantee future results. Indexes are unmanaged and cannot be invested in directly.

    Market shift toward "value" investing continued in Q4

    The fourth quarter also saw a continuation of the shift in performance leadership among investment styles that began in Q3, with "value" leading after an extended period of "growth" leadership in recent years. Value investments tend to have lower valuations as measured by price-to-earnings (P/E) and other metrics, slower growth and higher dividend yields. Growth investments tend to have faster earnings growth and higher valuations.

    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 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.

    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. Whether the shift to "value" leadership that occurred in the second half of 2019 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 Q4 and YTD, all portfolios across the risk spectrum delivered positive performance. More aggressive portfolios delivered the strongest returns as would be expected during periods of strong stock market performance. More conservative portfolios delivered positive returns as well, while also helping to moderate the ups and downs during the year's volatile periods. 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 longer-term gains but with greater stability.

    Looking ahead to Q1 2020

    Heading into 2020, the U.S. economy remained split between continued weakness in manufacturing and business investment, offset by strong employment and healthy consumer spending. After three rate cuts in 2019, the Fed appeared poised to hold short-term interest rates steady in 2020. As a result, inflation and longer-term interest rates were expected to move higher. Global growth remained solid, and trade talks with China appeared to be making tentative progress. However, uncertainties continued to cloud the outlook, including trade wars, a U.S. presidential election, Brexit, and others. While fears of imminent recession have faded, concerns remain over whether the slowdown in manufacturing might spread to jobs and consumers.

    With U.S. stock valuations above their long-term averages due to the Q4 rally and rosy investor sentiment, stocks are likely to remain volatile and highly reactive to shifting headlines. Investors will be looking for U.S. corporate earnings growth and positive trade developments to help support current valuations and potentially push markets higher in coming quarters. In international markets, stock valuations remain below their long-term averages, with potentially more upside than U.S. stocks if global growth were to accelerate.

    Following the strong gains of 2019, it's important to take a moment to reflect on your longer-term goals and why you're invested in a diversified portfolio. While stocks delivered strong gains in 2019, markets are volatile by nature as investors were reminded with the market correction at the end of 2018. Maintaining a disciplined approach based on time-tested investing principles such as diversification, rebalancing, ignoring short-term market noise, and keeping costs low are among the keys to long-term investment success.

    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.

    (0120-9MMR)


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