Performance July 11, 2017

    Key Themes

    • Performance leadership has shifted strongly to international investments in 2017 as global growth broadens. International stocks post their strongest first half of the year since 1998.
    • The S&P 500® Index of U.S. large-cap stocks delivers its strongest first half of the year since 2013.
    • Fed raises short-term rates for second time in 2017, but bonds provide moderate gains as longer-term rates decline YTD.
    • Market-cap indexing takes the lead after fundamental indexing led strongly in 2016, illustrating why Schwab Intelligent Portfolios includes both forms of indexing.
    • All portfolios across the risk spectrum, from conservative to aggressive, deliver positive returns during Q2 2017 and YTD.

    How did financial markets do in Q2 2017?

    Financial markets around the world delivered exceptionally strong returns during the first half of the year while volatility took an extended vacation. Performance leadership has shifted strongly to international markets in 2017, helped by both a weaker U.S. dollar and lower valuations than the U.S. stock market. As Figure 1 illustrates, international markets were the top performers during both Q2 and YTD. International developed-market large-cap stocks gained 6.1% during Q2 and 13.8% YTD in their strongest first half of the year since 1998. International small caps and emerging markets did even better, each posting their strongest first half since 2009.

    U.S. stock market returns were also strong, with the S&P 500 Index gaining 3.1% during Q2 and 9.3% YTD in its strongest first half since 2013. The index has now posted seven consecutive quarters of positive returns. U.S. small-cap stocks were the laggard with a gain of 5.0% YTD, following their strong rally at the end of 2016. As markets moved steadily higher during the first half of 2017, market volatility fell to its lowest levels since the early 1990s. Gold, a defensive asset class, was one of the few investments that performed poorly during Q2 as global political risk and inflation expectations both declined, though it remains a strong performer YTD.

    While markets were exceptionally calm during the first half of 2017, these placid periods are often followed by a pickup in volatility. The downturn among technology stocks at the end of Q2 following their strong run this year is an important reminder that pullbacks within a bull market are healthy and occur from time to time. Whether the calm continues into the second half of the year or markets potentially become more turbulent, a diversified investment approach such as that of Schwab Intelligent Portfolios is designed to help moderate potential volatility so that you can stay focused on your longer-term financial goals.

    Figure 1: Market Performance (Ranked by Q2 2017 total return)
    Total returns (%)
    Asset class Apr May Jun Q2 YTD
    International small-cap stocks 4.3 3.7 0.0 8.1 16.7
    Emerging market stocks 2.2 3.0 1.0 6.3 18.4
    International large-cap stocks 2.5 3.7 -0.2 6.1 13.8
    International bonds 1.4 2.2 -0.1 3.6 6.1
    U.S. large-cap stocks 1.0 1.4 0.6 3.1 9.3
    Investment-grade corporate bonds 1.1 1.2 0.3 2.5 3.8
    U.S. small-cap stocks 1.1 -2.0 3.5 2.5 5.0
    High-yield bonds 1.1 0.9 0.1 2.2 4.7
    Emerging market debt 0.2 1.8 -0.1 1.8 8.8
    U.S. real-estate investment trusts (REITs) 0.0 -0.8 2.3 1.5 2.1
    Treasury bonds 0.7 0.5 -0.3 0.8 1.5
    Gold & other precious metals 0.6 0.4 -2.8 -1.8 6.9

    Source: Morningstar Direct, as of June 30, 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 remain an important part of a diversified portfolio

    Bonds also delivered positive returns during Q2 and the first half of 2017 despite Fed rate hikes in March and again in June. While the Fed has been slowly raising short-term rates, longer-term interest rates have moved slightly lower in 2017. For example, the yield on the 10-year Treasury declined from 2.45% at the beginning of the year to 2.31% at the end of June. Among U.S. bonds, high-yield and investment-grade corporate bonds were the strongest performers in both the quarter and first half. International bonds were further helped by the weaker U.S. dollar. While the Fed is expected to continue to raise rates at a gradual pace going forward, it’s important to remember that bonds 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 the first half of 2017. Market cap-indexing led by between approximately 2.0 and 7.6 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 Q2 and YTD 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 and non-traditional bonds. More conservative portfolios saw more moderate gains due to their larger allocations to a diversified mix of 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 Q3 2017

    Heading into the second half of 2017, Schwab’s view is that global stocks may continue to post gains as earnings growth continues. Global economic growth is strengthening, with all of the world’s top 20 economies growing so far this year in the broadest global growth since 2010.

    While recession risk appears to remain low over the next 12 months, the recent period of exceptionally low market volatility is unlikely to continue. Markets are volatile by nature and most years tend to see a significant pullback at some point. Investing in a diversified portfolio consistent with your goals and risk tolerance and maintaining the discipline to navigate through these inevitable periods of turbulence while sticking with your financial plan 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®, 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 market stocks. For more information on Fundamental Indexing, see https://intelligent.schwab.com/public/intelligent/blog/fundamentally-weighted-etfs.html

    Indexes used in Figure 1 are international small-cap stocks, MSCI EAFE small cap Index; emerging markets stocks, MSCI Emerging Markets Index; international developed market large-cap stocks, MSCI EAFE Index; international bonds, Bloomberg Barclays Global Aggregate ex-USD Bond Index; U.S. large-cap stocks, S&P 500® Index; investment-grade corporate bonds, Bloomberg Barclays U.S. Corporate Investment Grade Index; U.S. small cap stocks, Russell 2000® Index; high yield bonds, Bloomberg Barclays High Yield Very Liquid Index; emerging markets debt, Bloomberg Barclays Emerging Markets Local Currency Government Bond 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; gold and other precious metals, S&P GSCI Precious Metals 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 markets stocks, Russell Fundamental Emerging Markets Large Company Index vs. MSCI Emerging Markets Index.

    (0318-8J2V)


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