Schwab Intelligent Portfolios January 31, 2019

    Key Themes

    • The U.S. stock market declined sharply during Q4 in its second correction of 2018 and its first negative year in a decade. While growth is slowing and volatility has increased, the economic expansion continues and we remain cautiously optimistic but watchful.
    • The benefit of including defensive asset classes as part of a well-diversified portfolio was demonstrated in 2018 as cash provided its intended ballast and asset classes such as gold and Treasuries delivered positive returns during the periods of turbulence.
    • International investments generally outperformed U.S. investments during Q4 after being buffeted by numerous headwinds throughout the year, illustrating the benefits of diversification across geographies as well as asset classes.
    • In a challenging year, more conservative portfolios outperformed more aggressive portfolios, with broad global diversification illustrating its benefit in helping moderate overall portfolio drawdowns as stocks tumbled during the year's two market corrections.

    How did financial markets do in Q4 2018?

    The fourth quarter of 2018 brought a sharp downturn for the U.S. stock market on concerns about slowing global growth, the effects of Fed interest rate increases, trade disputes, and a partial government shutdown. The stock swoon resulted in the second U.S. equity market correction in 2018, a year book-ended by corrections in both the first and fourth quarters.

    The quick reversal in Q4 served as a strong reminder of the benefits of global diversification and avoiding short-term performance chasing. After surging to new highs during Q3 on the backs of a handful of technology stocks, the S&P 500® Index plunged 13.4% during Q4 in its worst quarter since 2011 and its worst December since the Great Depression. At its low, the index closed just short of a 20% decline from its September peak that would have marked the end of the nearly decade-long bull market. While stocks bounced higher in the final days of the year, 2018 ended with the first annual decline since 2008.

    A bright spot during the quarter was defensive asset classes such as cash, gold, and Treasuries, illustrating the importance of including them as part of a well-diversified portfolio. As stocks plunged, defensive investments provided ballast and positive returns during the quarter that helped offset the stock declines, moderating overall portfolio declines for diversified investors.

    Figure 1: Market Performance (ranked by Q4 2018 total return)
    Total returns (%)
    Asset class Q4 Q3 2018 2017
    Gold and other precious metals 7.0 -5.4 -3.6 12.0
    U.S. Treasuries 2.7 -0.2 1.5 1.3
    Emerging markets bonds 2.5 -0.2 -3.4 14.3
    Securitized bonds 2.0 -0.1 1.0 2.5
    Investment-grade corporate bonds -0.2 1.0 -2.5 6.4
    High-yield bonds -4.7 2.6 -2.6 6.8
    U.S. real estate investment trusts (REITs) -6.1 1.1 -3.8 4.3
    Emerging markets stocks -7.5 -1.1 -14.6 37.3
    International large cap stocks -12.5 1.4 -13.8 25.0
    U.S. large cap stocks -13.5 7.7 -4.4 21.8
    International small cap stocks -16.0 -0.9 -17.9 33.0
    U.S. small cap stocks -20.2 3.6 -11.0 14.6

    Source: Morningstar Direct, as of December 31, 2018. Performance figures shown are total returns for each asset class during the designated period. Indexes used are gold and other precious metals, S&P GSCI Precious Metals Index; U.S. Treasuries, Bloomberg Barclays U.S. Treasury 3-7 Year Bond Index; emerging markets bonds, Bloomberg Barclays Emerging Markets Local Currency Government Bond Index; securitized bonds, Bloomberg Barclays US Securitized Bond Index; investment-grade corporate bonds, Bloomberg Barclays U.S. Corporate Investment Grade Index; high-yield bonds, Bloomberg Barclays High Yield Very Liquid Index; U.S. real estate investment trusts, S&P United States REIT Index; emerging markets stocks, MSCI Emerging Markets Index; international developed market large cap stocks, MSCI EAFE Index; U.S. large cap stocks, S&P 500® Index; international small cap stocks, MSCI EAFE small cap Index; U.S. small cap stocks, Russell 2000® Index. Past performance does not guarantee future results. Indexes are unmanaged and cannot be invested in directly.

    Shifts in performance leadership underscore the benefits of global diversification

    In many ways, Q4 was nearly the mirror image of Q3, with weak performers during Q3 becoming top performers in Q4 and vice versa. Gold topped the charts with a gain of 7.0% as U.S. dollar strength moderated and investors sought a haven amid the stock declines. Treasuries also advanced as long-term interest rates moved lower on a more dovish Fed following its December rate hike, its fourth of 2018. International investments also did better after a mostly tough year as currency movement and other headwinds eased, with emerging markets bonds shifting to a top performer and emerging markets stocks significantly outperforming U.S. stocks.

    These shifts in performance leadership can also be seen in the annual returns for 2018 and 2017. Few asset classes delivered positive returns in 2018, with bonds outperforming stocks and U.S. investments generally outperforming international. By contrast, returns in 2017 were strong across asset classes, with stocks outperforming bonds and international generally leading U.S. investments. Various asset classes constantly move up and down the performance rankings, underscoring the importance of diversification across asset classes and geographies.

    The renewed turbulence in 2018 is an important reminder that markets are volatile and unpredictable. This is why maintaining a disciplined approach based on time-tested investing principles such as establishing a financial plan based on your goals, investing in a diversified portfolio, and ignoring short-term market noise are among the keys to long-term investment success.

    How did Schwab Intelligent Portfolios do?

    For both Q4 and the full year, more conservative portfolios outperformed more aggressive portfolios as would be expected when equity markets are weak. While all but the most conservative portfolios declined in 2018, the broad diversification of Schwab Intelligent Portfolios helped to moderate overall portfolio drawdowns during the market corrections that began and ended the year.

    Times of turbulence illustrate the benefits of diversification as these are often the times when investors succumb to their emotions and abandon their long-term plans, potentially locking in short-term losses. Moderating the ups and downs as markets fluctuate can help keep you focused on your longer-term goals rather than overreacting emotionally when the markets inevitably become volatile from time to time.

    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 Q1 2019

    As 2019 begins, financial conditions have tightened and uncertainties abound regarding slowing global growth, trade tensions, a flat yield curve, and other geopolitical issues. Corporate earnings growth has moderated after consecutive years of double-digit gains, recession risk has increased, and market volatility is likely to remain elevated. On the positive side, however, global equity market valuations have come down, job growth and consumer spending remain strong, and the Fed has signaled a patient, data-dependent pace of rate hikes in coming quarters.

    Overall, Schwab's outlook remains cautiously optimistic but watchful. Potential gains are likely to be accompanied by continued market swings up and down as investors reassess global growth prospects. While times of turbulence can be challenging, maintaining a disciplined approach based on time-tested investing principles such as diversification, rebalancing, and ignoring short-term market noise can help keep you focused on your longer-term goals.

    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.

    The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

    All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness, or reliability cannot be guaranteed.

    Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

    Investing involves risks including possible loss of principal.

    Please read the Schwab Intelligent Portfolios disclosure brochures for important information, pricing, and disclosures relating to Schwab Intelligent Portfolios. Schwab Intelligent Portfolios® is made available through Charles Schwab & Co. Inc. ("Schwab"), a dually registered investment advisor and broker dealer. Portfolio management services are provided by Charles Schwab Investment Advisory, Inc. ("CSIA"). Schwab and CSIA are subsidiaries of The Charles Schwab Corporation.

    Diversification and rebalancing strategies do not ensure a profit and do not protect against losses in declining markets. International investing may involve greater risk than U.S. Investments due to currency fluctuations, unforeseen political and economic events, and legal and regulatory structures in foreign countries. Investing in emerging markets may accentuate these risks. Data contained herein from third party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed. The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.


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