2020 Schwab market outlook - Schwab experts share their perspectives on the markets and investment environment - Charles Schwab Investment ...
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2020 Schwab market outlook Schwab experts share their perspectives on the markets and investment environment
Market and investment
outlook on:
1 U.S. stocks and economy
2 Global stocks and economy
3 Fixed income
Contributors
Liz Ann Sonders Omar Aguilar, PhD Bill McMahon, CFA
Chief Investment Strategist, Chief Investment Officer, Chief Investment Officer for
Charles Schwab & Co., Inc. Charles Schwab Investment ThomasPartners Strategies,
Management, Inc. Charles Schwab Investment
Advisory, Inc.
Jeffrey Kleintop, CFA Kathy Jones Brett Wander, CFA
Chief Global Investment Strategist, Chief Fixed Income Strategist, Chief Investment Officer,
Charles Schwab & Co., Inc. Schwab Center for Financial Research Charles Schwab Investment
Management, Inc.
2020 Schwab market outlook | 2
EXECUTIVE SUMMARY
What may tip the scale?
Trade wars and a global manufacturing decline Each section in this 2020 Schwab market outlook—
weighed on the economies in 2019, although central U.S. stocks and economy, global stocks and
bank rate cuts and resilient consumers provided a economy, and fixed income—will discuss ways to
positive stock market counterbalance. The question prepare for potentially changing conditions. Having
heading into 2020 is: What may tip the scale? a financial plan and an appropriately diversified
Will ongoing trade uncertainty and weakened portfolio are two key first steps for weathering any
manufacturing hurt job growth, finally dragging down market environment. Note that this is just a one-year
the services and consumer side of the economy? Or outlook, and investors should keep their investing
will interest rate cuts and a resolution of the trade time horizon in mind before reacting to any forecasts.
war spark a fresh round of global economic growth?
Key takeaways
• The U.S. economy will likely remain split in early 2020, with manufacturing and business
investment still struggling amid trade uncertainty but services activity and consumer
spending healthy.
• A resolution of the U.S.-China trade war could reverse business uncertainty and unleash
investment. However, a global recession could occur if the manufacturing slowdown
spreads to jobs and consumers.
• Ten-year Treasury yields should move higher in 2020 as recession fears ease. Barring a setback
on trade, yields could move back up to the 2.25% to 2.50% area.
2020 Schwab market outlook | 3
MARKET PERSPECTIVE
U.S. stocks and economy
Liz Ann Sonders
The dividing line remains firm
Key points U.S. economic growth slowed in 2019,
pulled down by weak business investment
• The U.S. economy will
and manufacturing activity. Although strength
likely remain bifurcated in
in consumer spending and services persists
early 2020. Manufacturing
heading in 2020, we expect stabilization—at best—in growth next
and business investment
year. Myriad uncertainties are clouding the outlook, including
may continue to struggle
earnings and the presidential election. Ongoing trade-war ambiguity
but services activity and
could further depress corporate confidence and investment.
consumer spending may
continue to be healthy.
A key risk in 2020 is that manufacturing weakness and
• The Fed’s 2019 rate cuts business investment fatigue could hurt services activity and
should support the economy consumer spending by depressing job growth. Although the U.S.
and stocks, although the unemployment rate (a lagging indicator) remains low, weekly initial
cuts are only a partial cure jobless claims (a leading indicator) in manufacturing-oriented states
for what ails manufacturing have been rising. As such, U.S. payroll growth may weaken if limited
and corporate animal spirits. headway is made on a comprehensive trade deal. However, global
economic stabilization could be positive for U.S. growth.
• A preliminary U.S.-China
trade deal might stabilize
A lift from earnings?
corporate confidence, but a
strong business investment We expect bouts of market volatility will persist in 2020. Trade
environment likely requires news may continue to drive market swings in both directions,
a comprehensive trade deal. absent a comprehensive U.S.-China trade deal. Investor sentiment
should also be a factor in market swings, with late-2019’s new
• Trade-war progress and
highs ushering in elevated investor optimism (a contrarian indicator
global manufacturing
at extremes). Investor sentiment may also continue to swing more
stabilization are required for
widely than usual, with recent new highs elevating optimism, only
U.S. manufacturing activity
to be dented by negative trade news.
to improve.
Earnings are expected to accelerate in 2020, but this expectation
is partly predicated on a positive outcome to the U.S.-China trade
war, which remains uncertain. In addition, due to the effects of
How does S&P 500® Index tariffs and rising labor costs, profit margins could come under
pressure in 2020. Macro conditions, including easier monetary
performance compare
policy and lending conditions, supported price-earnings (P/E)
with corporate profits?
expansion in 2019, but these effects are fading. The historically
wide gap between stock market performance and corporate
View Figure 1
earnings suggests the latter needs to accelerate.
on page 10.
2020 Schwab market outlook | 4
INVESTMENT PERSPECTIVE
U.S. stocks and economy
Omar Aguilar
Greater performance dispersion Portfolio
Keeping in mind my focus on equities and implications
asset-allocation strategies, in an economic • Consider bringing over- and
slowdown with geopolitical uncertainty and underweights back in line
accommodating central banks, we expect with long-term strategic
increased volatility and stock performance dispersion in 2020. asset allocations, as
From a style standpoint, overextended valuations on defensive informed by an investment
and momentum-based strategies that have been outperforming risk profile.
emphasize the potential benefits of rebalancing toward long-term
• Strategic beta strategies
strategic allocations.
in ETF or mutual fund
After the longest bull market in recent history, consider investment vehicles may provide an
strategies and styles that might benefit from volatility and mean effective counterbalance
reversion, including value, strategic beta, and high-quality if momentum-based
cyclical sectors. We expect a range of behavioral finance biases strategies stumble.
to be triggered by next year’s politically charged and bifurcated • Carefully evaluate
economic environment—including risk aversion, the recency investment plans to ensure
bias, framing, and overconfidence—with some biases materially that asset allocations do not
influencing one generation more than another. reflect behavioral biases.
Bill McMahon • We expect valuations
to matter in 2020—unlike
Valuations will matter the momentum-driven
When viewed through an active management environment in recent years.
lens, value has been out of favor for years as • The energy sector has
investors have chased a narrow subset of experienced pronounced
U.S. large-cap growth firms. Despite this CapEx retrenchment and
trend, we expect valuations to matter in 2020 and look to identify may offer true value for
companies positioned to deliver: (1) high and recurring free cash investors willing to assume
flows, (2) a meaningful dividend yield, and (3) a high propensity the corresponding risks.
to grow dividends.
• Health care is another
As investors have emphasized momentum-based factors, area where select firms
traditional defensive sectors have experienced increased investor offer appealing potential,
interest and higher multiples as a result. Many low volatility although the sector may
strategies have seen their constituents become expensive face appreciable political
amid the search for companies with defensive attributes and risks next year.
less cyclicality. Health care may offer select opportunities for
investors willing to tolerate the associated political risks as a
number of multinational operators offer reasonable valuations
and attractive fundamental characteristics.
2020 Schwab market outlook | 5
MARKET PERSPECTIVE
Global stocks and economy
Jeffrey Kleintop
New heroes are needed
Key points International stocks’ double-digit gains for
2019 may be attributed to central bankers’
• Headwinds from the trade-
actions, but trade deals and fiscal policies
induced slump in output and
may be the real heroes in 2020.
investment are unequally
affecting countries and
As central banks shifted to interest rate cuts in 2019, investors
regions, potentially fueling
drove up valuations for international stocks, believing that these
recessions in select areas
guardians of the economy could defeat any threat to global growth.
around the world.
In 2020, growth may depend on comprehensive trade deals and
• A broad global recession fiscal stimulus to reverse the slowdown in manufacturing and
could occur if the business investment. If tariffs are not lifted before businesses cut
manufacturing slowdown jobs, it may undermine the consumer spending supporting the
spreads to jobs and world’s economy.
consumers.
Manufacturing-focused economies, like Germany’s, are at the
• A resolution of the U.S.-
leading edge of the slowdown. This may lead to fiscal stimulus,
China trade war could
with an increasing number of leaders already announcing new
reverse business uncertainty
tax cuts and spending initiatives in their 2020 budgets.
and unleash investment.
• As central banks become A year of surprises?
less effective in boosting International stock valuations are below long-term averages,
growth, the focus may reflecting 2019’s lackluster global growth and fears of potential
turn to government fiscal weakness ahead. As international stocks tend to be more
policy, such as tax cuts or economically sensitive than U.S. stocks, they may offer more
increased spending, for upside potential should growth reaccelerate.
economic support.
Compared with the past 20 years, global stock markets are now
less synchronized with each other, suggesting a globally diversified
portfolio may provide effective management of market volatility.
How have long-term
asset trends responded A yield curve inversion, such as when the 10-year Treasury yield
falls below the three-month Treasury yield, can be a negative
to past yield curve
market signal preceding global recessions. As important, it also
inversions? has signaled trend reversals in relative performance of global
growth and value stocks, international large- and small-cap
View Figure 2
stocks, as well as U.S. and international stocks. In 2020, new
on page 10.
leadership by value, large-cap, and international stocks may
follow 2019’s inversion.
2020 Schwab market outlook | 6
INVESTMENT PERSPECTIVE
Global stocks and economy
Omar Aguilar
Overseas equities look compelling Portfolio
With my focus on equities and asset-allocation implications
strategies in mind, ignoring international • For home-biased investors,
equities could prove costly in 2020. Recent- an allocation to mega-cap
year underperformances, attractive relative stocks in the S&P 500
valuations, U.S. dollar stability, long-term demographic tailwinds, Index may seem sufficient
and a potential global recovery aided by fiscal stimulus may benefit for diversification; however,
overseas stocks next year. this approach ignores
many potential benefits of
For home-biased investors, an allocation to mega-cap stocks in investing overseas.
the S&P 500 Index may seem sufficient for diversification, while
minimizing currency risks. However, this approach ignores the fact • Evaluate the potential
that non-U.S.-based firms have often generated some of the better benefits of international
annual single-stock returns since the world began recovering from strategic beta strategies if a
the financial crisis. A more direct and effectively diversified overseas more material allocation to
allocation might be to consider opportunities that could benefit from overseas stocks is the target.
economic recovery and undervaluation, like international strategic • When actively searching for
beta strategies, especially given the mid-September shift away from international equities, think
momentum-based outperformance. about taking a closer look
at firms with high free cash
Bill McMahon flow yields, dividends, and
Consider a best-of-both approach reasonable valuations.
When viewed through an active management • Instead of buying emerging
lens, we like the outlook for select international market equities directly,
firms that generate high free cash flow yields. consider looking for stocks
High free cash flow yields convey critical of developed-market firms
information about a company’s financial health, making this a with established emerging
powerful metric. In addition, although firms are not required to market franchises that
pay dividends, doing so demonstrates a commitment to capital potentially incorporate a
stewardship. Lastly, try not to overpay—even traditional value best-of-both approach.
stocks can become overpriced.
Developed-market companies with large emerging market
franchises that enjoy well-established distribution networks are
particularly appealing. Most of these firms endeavor to capitalize
on the explosive growth of emerging market middle classes that
may drive future economic activity in the years ahead. Access
to this growth engine through a developed-market firm provides
a potentially more stable approach than buying equities in the
target market.
2020 Schwab market outlook | 7
MARKET PERSPECTIVE
Fixed income
Kathy Jones
Easing recession fears should boost
bond yields
Key points
Ten-year Treasury yields should move
• Three interest rate cuts
higher in 2020 as recession fears ease.
by the Fed in 2019
The lagged impact of the Federal Reserve’s
successfully “un-inverted”
interest rate cuts, signs of stabilization in the global economy,
the fixed income yield curve,
and a modest uptick in inflation expectations should provide
likely placing monetary
a boost to intermediate- and long-term bond yields.
policy on hold for the
foreseeable future.
The risk to our outlook is the ongoing threat of trade tariffs
• Barring a trade-war setback, weighing on business investment. Barring further setbacks
10-year Treasury yields on trade, 10-year Treasury yields could move up to the 2.25%
could move back to the to 2.50% region, while the chances of a drop below the 2019
2.25% to 2.50% range as low of 1.52% are diminishing as global recession fears abate.
recession fears ease, which
would make longer-term With the yield curve now “un-inverted” and signs of economic
bonds compelling. stabilization, the Fed will likely be on hold for the foreseeable future.
• The U.S. dollar should Inflation expectations may rise
remain firm relative to
other major currencies on The key to higher yields on intermediate- to long-term bonds
continued U.S. economic will be rising inflation expectations. With the economy showing
outperformance, with any resilience and core inflation edging up, inflation expectations
additional dollar gains likely should move higher, potentially adding 50 to 75 basis points¹
to be small. to 10-year Treasury yields. Breakeven inflation rates are low,
so Treasury Inflation-Protected Securities (TIPS) are attractive
relative to nominal Treasuries for those looking for inflation
protection.
How have inflation Despite signs of economic stabilization, we see risks in the more
expectations changed? aggressive segments of the fixed income market, like high-yield
securities, bank loans, and emerging market bonds. Given already
View Figure 3 tight credit spreads and where we are in the business cycle,
on page 10. downgrade and default risks for high-yield issuers may start to
rise. As a result, we suggest reducing high-yield bond exposure
and moving up in credit quality in the investment-grade market.
1. A basis point is one hundredth of 1.00%, or 0.01%; 50 basis points equals 0.50%.
2020 Schwab market outlook | 8
INVESTMENT PERSPECTIVE
Fixed income
Brett Wander
A careful approach is critical Portfolio
Fixed income investors have much to consider implications
when contemplating current market conditions • Rather than overreaching
and geopolitical uncertainties that will for yield, consider centering
undoubtedly continue into the New Year. With fixed income allocations on
this backdrop in mind, we believe that a careful approach to fixed a high-quality core position
income allocations will be critical in 2020. in top-quality securities like
Treasuries and investment-
Most important among our suggestions is to avoid overreaching grade corporate bonds.
for yield. Instead, center fixed income allocations on a high-quality,
liquid core position in Treasuries, and avoid over-subscribing to • Think about a bond ladder
riskier debt that is far more correlated with equities than with strategy that invests in
top-quality bonds. Similarly, be highly selective where actively multiple maturities, rather
managed fixed income funds are concerned, and carefully monitor than focusing on short-
investments in these strategies to ensure that their risk profiles term securities due to
don’t unexpectedly shift in the low-rate environment. compressed yield spreads
and the relative flatness of
From a maturity standpoint, a distributed approach across the the curve.
curve seems the most prudent strategy. Nothing is free when • Consider an allocation
investment risk is considered, and assuming a short-maturity to TIPS, given that these
approach to capitalize on rates similar to those further along the securities are currently
maturity spectrum poses risks. In particular, a short-maturity trading at attractive prices
portfolio creates higher reinvestment risks over time and reduces and that TIPS are specifically
the potential for larger total returns if economic conditions engineered to provide
unexpectedly downshift and rates fall. So consider a bond ladder. protection against inflation.
Surges in economic growth have historically fueled inflation spikes,
an environment for which TIPS are well suited. Under present
conditions, inflation and breakeven rates on TIPS are low, allowing
these securities to trade at attractive levels. It makes sense to add
an allocation to TIPS even though the risk of unexpected inflation
is currently low.
When thinking about next year’s market dynamics, considerable
fatigue seems to exist where the trade war, Brexit, and impeachment
talks are concerned. Given these factors, investors will likely be
far better off not placing enormous bets on precise outcomes but
instead rebalancing toward long-term allocations for 2020.
2020 Schwab market outlook | 9
Charts
U.S. stocks and economy
Figure 1: The gap between S&P 500 Index performance and corporate profits is wide
3,500 3,500
3,000 3,000
2,500 2,500
2,000 2,000
1,500 1,500
1,000 1,000
500 500
0 0
1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019
Shaded areas represent recessions. S&P 500 Index (level) Corporate after-tax profits* (in billions)
*With inventory valuation and capital consumption adjustments.
Sources: Charles Schwab, Bloomberg, Bureau of Economic Analysis. S&P 500 Index data as of 11/29/2019. Corporate after-tax profits data as of 9/30/2019.
Global stocks and economy
Figure 2: Historically, long-term asset class trends have tended to reverse after yield curve inversions
4.20 1.75
3.60 1.50
3.00 1.25
2.40 1.00
1.80 0.75
1.20 0.50
0.60 0.25
0.00 0.00
1983 1987 1991 1995 1999 2003 2007 2011 2015 2019
MSCI USA Index / MSCI EAFE Index (right scale) MSCI EAFE Index / MSCI USA Index (left scale)
The left vertical axis and light blue line represent the MSCI EAFE price index divided by the MSCI USA price index. The right vertical axis and dark blue line represent the
MSCI USA price index divided by the MSCI EAFE price index. Yield curve inversions reflect the three-month/10-year Treasury yield curve.
Sources: Charles Schwab, Bloomberg. Data as of 11/13/2019. Past performance is no guarantee of future results.
Fixed income
Figure 3: Inflation expectations are relatively low
2.4%
2.2%
2.0%
1.8%
1.6%
1.4%
2015 2016 2017 2018 2019
5-Year, 5-Year Forward Inflation Expectation Rate Fed inflation target rate
Notes: A measure of the average expected inflation over the five-year period that begins five years from the date data are reported. The rates are comprised of generic U.S.
breakeven forward rates: nominal forward 5 years minus U.S. inflation-linked bonds forward 5 years.
Source: Blomberg 5-Year, 5-Year Forward Inflation Expectation Rate (USGG5Y5Y Index). Daily data as of 11/14/2019.
2020 Schwab market outlook | 10OUR CONTRIBUTORS
Schwab market and investment experts
Liz Ann Sonders Omar Aguilar, PhD
Chief Investment Strategist, Chief Investment Officer,
Charles Schwab & Co., Inc. Charles Schwab Investment Management, Inc.
Liz Ann is responsible for investment strategy, market and Omar is responsible for CSIM’s equity and asset-allocation
economic analysis, and investor education. She is a regular mutual funds and ETFs. He has more than 20 years’ experience
guest on CNBC, Bloomberg TV & Radio, CNN, Fox Business in equity markets, including managing quantitative equity, asset-
News, Nightly Business Report, and PBS NewsHour. She was allocation, and multi-manager strategies. He was a Fulbright
named to SmartMoney’s “Power 30” list of most influential Scholar at Duke University’s Institute of Statistics and Decisions
people on Wall Street. She earned a Bachelor of Arts in Sciences, where he earned an MS and PhD. He also holds a BS
economics and political science from the University of Delaware in actuarial sciences and a graduate degree in applied statistics
and an MBA in finance from Fordham University’s Gabelli from the Mexico Autonomous Institute of Technology.
School of Business.
Jeffrey Kleintop, CFA
Bill McMahon, CFA Chief Global Investment Strategist,
Chief Investment Officer for ThomasPartners Strategies, Charles Schwab & Co., Inc.
Charles Schwab Investment Advisory, Inc. Jeffrey is responsible for analyzing international markets,
Bill is the CIO and a member of the portfolio management trends, and events to help investors understand their
team responsible for investment management, research, significance and financial implications. He is a regular
and portfolio construction for ThomasPartners strategies. guest on CNBC, Bloomberg, Fox Business News, PBS,
He has more than 20 years’ experience in the financial services and ABC News—and was cited in the Wall Street Journal
industry. He began his career at State Street Corporation, as one of “Wall Street’s best and brightest.” Jeffrey earned
with the latter half of his tenure with State Street Global a BS in business administration from the University of
Advisors. He earned a BA in economics from Stonehill College Delaware and an MBA from Pennsylvania State University.
and an MBA from Bentley College.
Brett Wander, CFA
Kathy Jones Chief Investment Officer,
Chief Fixed Income Strategist, Charles Schwab Investment Management, Inc.
Schwab Center for Financial Research Brett is responsible for all aspects of CSIM’s fixed income
Kathy is responsible for credit market and interest rate and money market portfolios. For more than 25 years, he has
analysis, as well as fixed income education for investors. She been involved in the design, development, and oversight of active,
has studied global credit markets extensively as a fixed income indexed, and alternative fixed income strategies. His expertise
investment strategist. Prior to joining Schwab in 2011, she was spans global and domestic markets and sectors. He is a published
a fixed income strategist with Morgan Stanley Smith Barney. author and frequent industry speaker. Brett earned a BS in
She earned a BA in English literature from Northwestern system science engineering from the University of California,
University and an MBA in finance from Northwestern Los Angeles and an MBA from the University of Chicago.
University’s Kellogg Graduate School of Management.
2020 Schwab market outlook | 11Charles Schwab Investment Management
With a straightforward lineup of core products and solutions for building the
foundation of a portfolio, Charles Schwab Investment Management advocates
for investors of all sizes with a steadfast focus on lowering costs and reducing
unnecessary complexity.
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. Supporting documentation for any claims or statistical information is
available upon request.
Forecasts contained herein are for illustrative purposes only, may be based upon proprietary research, and are developed through analysis of historical public data.
Please note that this content was created as of the specific date indicated and reflects the author’s views as of that date. It will be kept solely for historical purposes, and
the author’s opinions may change, without notice, in reaction to shifting economic, business, and other conditions. Supporting documentation for any claims or statistical
information is available upon request.
Past performance is no guarantee of future results, and the opinions presented cannot be viewed as an indicator of future performance.
Investing involves risk including loss of principal.
Fixed income securities are subject to increased loss of principal during periods of rising interest rates. Fixed income investments are subject to various other risks, including
changes in credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications, and other factors. High-yield bonds and lower-rated
securities are subject to greater credit risk, default risk, and liquidity risk.
International investments involve additional risks, which include differences in financial accounting standards, currency fluctuations, geopolitical risk, foreign taxes and
regulations, and the potential for illiquid markets. Investing in emerging markets may accentuate these risks.
Indexes are unmanaged, do not incur fees or expenses, and cannot be invested in directly. For more information on indexes please see schwab.com/indexdefinitions.
Diversification, asset-allocation, and rebalancing strategies do not ensure a profit and do not protect against losses in declining markets. Rebalancing may cause investors to
incur transaction costs, and, when rebalancing a non-retirement account, taxable events may be created that may affect your tax liability.
Treasury Inflation Protected Securities (TIPS) are inflation-linked securities issued by the U.S. government whose principal value is adjusted periodically in accordance with
the rise and fall in the inflation rate. Thus, the dividend amount payable is also impacted by variations in the inflation rate, as it is based upon the principal value of the bond. It
may fluctuate up or down. Repayment at maturity is guaranteed by the U.S. government and may be adjusted for inflation to become the greater of the original face amount at
issuance or that face amount plus an adjustment for inflation.
Tax-exempt bonds are not necessarily a suitable investment for all persons. Information related to a security’s tax-exempt status (federal and in-state) is obtained from third-
parties, and Schwab does not guarantee its accuracy. Tax-exempt income may be subject to the alternative minimum tax (AMT). Capital appreciation from bond funds and
discounted bonds may be subject to state or local taxes. Capital gains are not exempt from federal income tax.
This information does not constitute and is not intended to be a substitute for specific individualized tax, legal, or investment planning advice. Where specific advice is necessary
or appropriate, Schwab recommends consultation with a qualified tax advisor, CPA, financial planner, or investment manager.
Small-cap investments are subject to greater volatility than those in other asset categories.
A bond ladder, depending on the types and amount of securities within the ladder, may not ensure adequate diversification of your investment portfolio. This potential lack of
diversification may result in heightened volatility of the value of your portfolio. You must perform your own evaluation of whether a bond ladder and the securities held within it
are consistent with your investment objective, risk tolerance, and financial circumstances.
On page 6, the phrase guardians of the economy refers to global central banks.
©2019 Charles Schwab Investment Management, Inc. All rights reserved.
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