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The Best Way to Travel: Musings from Asia


Liz Ann Sonders

Liz Ann Sonders
Senior Vice President, Chief Investment Strategist, Charles Schwab & Co., Inc.

Liz Ann Sonders has a range of investment strategy responsibilities reaching from market and economic analysis to investor education, all focused on the individual investor. She analyzes and interprets the economy and markets on behalf of Schwab’s clients.

November 19, 2018

Member for

2 years 6 months
Submitted by Site Factory admin on November 19, 2018
The Best Way to Travel: Musings from Asia

There was keen interest in Schwab’s philosophy around long-term strategic and global asset allocation.

But Asians’ more trading-oriented approach to investing also meant a heightened focus on the FAANG stocks.

Tariffs, buybacks and the spread between “soft” and “hard” economic data in the United States rounded out the topics of most interest.

I spent last week in Asia—two days in Hong Kong, one day in Shanghai, and two days in Singapore—visiting our clients. It was a fascinating trip in some of my favorite cities in the world … well, in the case of Singapore, a city, island, and country all in one. I always find the Q&A sessions following my more formal presentations to be enlightening, no matter where I’m visiting; all the more so at times when I venture outside the United States. Today’s report will address the top-five questions or topics most on the minds of our Asian investors.

Time in the market …

The first topic, which was animatedly discussed—especially in Hong Kong—was around strategic asset allocation and the merits of broad global and strategic asset class diversification. I must admit that this discussion may not have happened at all were it not for one of the first visuals I showed at each of the eight formal presentations I did.

The well-known “investing quilt chart” below is less-well known outside of the United States. Some version of this is used by countless U.S. investment and money management firms to highlight the volatile nature of asset class rankings year-to-year, as well as the related merits of diversification. But as Asian investors are generally more trading-oriented, they tend to be less familiar with this type of analysis.

“Patternless” Investing Quilt Chart

Schwab Asset Class Quilt Chart

Source: Schwab Center for Financial Research with data provided by Morningstar, Inc. *Data thru October 31, 2018. Asset class performance represented by annual total returns for the following indexes: S&P 500® Index (US Lg Cap), Russell 2000® Index (US Sm Cap), MSCI EAFE® Net of Taxes (Int’l Dev), MSCI Emerging Markets IndexSM (EM), MSCI US REIT Index (REITs), S&P GSCI® (Comm.), Bloomberg Barclays U.S. Treasury Inflation-Linked Bond Index (TIPS), Bloomberg Barclays U.S. Aggregate Bond Index (Core US Bonds), Bloomberg Barclays U.S. High Yield Bond Index (High Yield Bonds), Bloomberg Barclays Global Aggregate Ex-USD TR Index (Int’l Dev Bonds), Bloomberg Barclays Emerging Markets USD Bond TR Index (EM Bonds), Citigroup U.S. 3-Month T-Bill Index (T-Bills). Moderate Diversified allocation based on total return with taxable bonds model allocation (24% U.S. stocks, 21% int’l stocks, 25% core bonds, 1% U.S. inflation protected securities, 5% int’l developed country bonds, 10% U.S. corporate high yield bonds, 5% int’l emerging markets bonds, 4% commodities, 5% cash). Past results are not an indication or guarantee of future performance. Returns assume reinvestment of dividends, interest, and capital gains. Indexes are unmanaged, do not incur fees or expenses, and cannot be invested in directly.

Our purpose in trotting this out consistently is to show that asset classes of every variety move in and out of favor and it is ultimately a somewhat random walk. It’s human nature to want to have a lot of exposure to what will be the best-performing asset class(es) each year; and to lower or eliminate the asset class(es) which will fall to the bottom of the rankings. However, it’s also human nature to use past performance as a guide to making those decisions.

As you can see if you study the quilt above, chasing the top performing asset class after the fact doesn’t tend to pay rewarding dividends. What we highlight instead is that a broadly diversified portfolio (our “moderately diversified” strategic asset allocation model in the white boxes) tends to smooth out the ride; ultimately generating healthy returns at the end of the period, with lower risk than all-or-nothing market timing. Remember, “time in the market is more important than timing the market.”

Frankly, I saw a few lightbulbs flicker on in our discussions and know that there were many of our Asian investors who were anxious to follow up with their financial consultants to discuss the merits of broad global and strategic diversification. That was great to see.

FAANG’s bite

As interesting as the aforementioned enlightenment about asset allocation was, there was still keen interest in shorter-term market gyrations; with a rash of questions about the FAANG stocks specifically, and tech leadership more broadly.

With the important caveat that I do no analysis at the individual company level, there were still a lot of questions about whether the FAANG stocks are likely to regain their leadership status and if not, where we see leadership in the near-to-medium term.

I gave a synopsis of the sector-based recommendation changes we made in mid-August; including the downgrade of the technology and financial sectors (from outperform to neutral) and upgrade of the utilities and REITs sectors (from underperform to neutral). Those changes left only one outperform rating—health care—and only one underperform rating—communications services. For more details on those changes, please see Brad Sorensen’s write-up.

As for the FAANG stocks, the conversation was particularly lively during my first client lunch in Singapore last Thursday. That was partly due to our “surprise” guest—my colleague and head of the Schwab Equity Ratings (SER) division of Schwab—Steve Grenier, who was in Singapore on holiday.

Below is a summary of the maximum drawdown for each of the FAANG stocks this year. As for the stocks’ SERs, if you are a Schwab client and are interested in their current ratings or doing additional investment research on these companies, please log into your account or speak with your financial consultant.

Facebook (FB)
          -36% (7/25/18 – 11/16/18)

Apple (APPL)
          -20% (10/03/18 – 11/14/18)

Amazon (AMZN)
          -25% (9/4/18 – 10/30/18)

Netflix (NFLX)
           -32% (7/9/18 – 11/16/18)

Alphabet (GOOGL)
           -20% (7/26/18 – 10/29/18)

All of these stocks are trading below both their 50-day and 200-day moving averages; and In light of the drubbing in stocks today as of this writing, the weakness could continue in the near-term. Let’s just say that we are not currently “itching” to upgrade technology back to outperform.

From the start of this year through the September 20 S&P 500 high, the consumer discretionary and technology stocks led the way, with about 19% gains for both sectors. However, since then, the only three sectors which are up this year are utilities, consumer staples and REITs—clearly a shift away from growth and momentum to value and defensiveness.

But there is a bigger story here and it’s one of “stealth” and/or “rolling” bear markets. Although none of the major U.S. equity averages is in traditional bear market territory (using the standard -20% definition), we have been experiencing a stealth or rolling bear market for much of this year.

Although not a comprehensive list, we have seen bear markets in the cryptocurrencies and the “short-volatility”-related vehicles (mostly inverse exchange-traded notes) earlier this year; followed by emerging markets; followed by the FAANGs; and followed more recently by oil.

Even within the U.S. equity indices, the underlying weakness is notable. As of October 26 this year, nearly 50% of stocks within the S&P 500 were down more than 20% from their recent highs.

Tariffs, tariffs, tariffs

Perhaps no surprise is the interest our Asian investors had in the trade “war” between the United States and China; and specifically the implications for the U.S. economy. I showed the following chart and table during my presentations, which breaks down the tariffs into imposed, pending and potential categories.

Tariffs’ Bite Getting More Painful

U.S. Tariffs as % of U.S. GDP
U.S. Tariffs as % of U.S. GDP

Source: Charles Schwab, Cornerstone Macro.

Although it’s been true to say the impact on the overall U.S. economy has been di minimis to date, that will not be the case going forward if the additional pending and potential tariffs kick in. In fact, the October correction (which is arguably ongoing) was partly triggered by an increasing number of companies beginning to put “meat on the bone” of what tariffs will mean to their business looking ahead.

In addition, the second quarter real gross domestic product (GDP) growth rate of 4.2% was somewhat inflated by companies front-running tariffs and boosting imports in advance. That inventory-building is set to reverse over the next couple of quarters, which means the expected one percentage point hit shown above would come off a smaller rate of growth—not to mention the ripple effects into the confidence, inflation and capital spending channels, among others.

Buybacks on fire

There was keen interest in the trends of corporate buybacks this year and whether the blistering pace is likely to persist. The chart below shows that the third quarter of this year is likely to set a record, with potential for a $200 billion quarter in terms of S&P 500 stock buybacks.

Buybacks’ Record Run

S&P 500 quarterly buybacks

Source: Charles Schwab, Standard & Poor’s.  September 2018 represents 3Q buybacks reported thru November 16, 2018. 

Although many investors were hoping that tax reform and the repatriation of overseas-held corporate cash would funnel money into longer-term capital investments, money has remained biased toward stock buybacks. According to J.P. Morgan, November is shaping up to be the strongest buyback month on record; and Goldman Sachs expects S&P 500 share repurchases to climb another 22% to $940 billion next year.

Soft winning over hard

Another topic about which there was a lot of fascination and conversation was the spread between how “soft data” is coming in relative to expectations versus the “hard data.” Soft data is for the most part survey- and confidence-based data—in other words, it measures the “attitudes” of the economy’s constituents. Hard data is quantifiable measures of economic activity.
As you can see in the surprise indexes in the chart below, the latest trends in the soft data have been better than expectations. That has been led by stronger-than-expected consumer confidence, which has been surprisingly resilient in the face of the weak equity market. In addition, you can see how uniquely long this period has been with soft data remaining above expectations.

On the other hand, the hard data has been underperforming expectations; with notable weakness among the housing components of the hard data set.

Soft Data Reigns Supreme Over Hard Data

Bloomberg Soft Data Surprise Index and Bloomberg Hard Data Surprise Index

Source: Charles Schwab, Bloomberg, as of October 31, 2018.

The most common question I received when discussing this divergence is whether a convergence is likely; and if so, is it more likely that the soft data catches down to the hard data, or the hard data catches up to the soft data. Although it could ultimately be a combination of the two; I think trade holds the key in the near-term.

If we were to see some sort of resolution to the current stand-off on trade between the United States and China, we could see the soft data remain resilient; perhaps paving the way for the hard data to play catch up. However, if the upcoming G20 meeting—at which Presidents Trump and Xi are scheduled to meet to talk trade—comes and goes without some sort of agreement, we might see the soft data catch down to the hard data.

All in all…

It was a great trip to visit our overseas investors. Although they have a reputation for being more trading-oriented, it was nice to witness their acknowledgement of the merits of longer-term diversified strategic asset allocation. However, their keen interest in the fate of the FAANG stocks suggests that shorter-term trends and factors like momentum (or lack thereof) also remain top of mind.

Follow Liz Ann Sonders on Twitter: @lizannsonders

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