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Portfolio > Economy & Markets > Fixed Income

Schwab ‘Optimistic’ About Equities, Developed Markets in Second Half

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Charles Schwab Investment Management on Thursday held its CIO midyear market outlook conference call, expressing optimism for equities and developed markets while predicting a Fed rate hike in the fourth quarter.

Omar Aguilar, chief investment officer for equities, said that global equity markets are facing a significant headwind due to the global market slowdown. In the U.S., Aguilar said, the first half of the year was “pretty soft,” with “very disappointing” consumer spending, despite a stronger dollar.

“Everything when we look at the data for the first half suggested that our economy, while it stayed on trend, it was not as fast growing as everybody expected.”

In the rest of the world, particularly developed markets, volatility was high. He predicted that will continue into the second half of the year, and added that he’s optimistic that at the end of the year equities will have a positive outcome “mostly because we expect the economy in the U.S. to be rebounding from the first half of the year.”

Aguilar said, “Between Greece, Europe, the ECB monetary stimulus, the Bank of Japan, Russia and China, we basically make Iran the best news that we’ve seen so far.”

He said the “unprecedented stimulus programs” in Europe and Japan in the first half of the year have worked as expected. “The volatility of those markets has gone down. The real yields on their government bonds have actually gone to negative territory in some cases, and the overall volatility of their equity markets has gone down, and as a result, their equity markets have gone up significantly higher than what we have in the U.S.”

Events in Greece, however, built up a headwind in Europe and around the world, Aguilar said, “because people have concerns about the outcome, more politically than economically.” He said that equity volatility increased following negative news about the situation there, but generally, the markets went back to where they were following positive news.

Emerging markets, however, are “not in the best shape.” Following the 2008 crisis and subsequent QE programs, Aguilar said “we saw a lot of liquidity flow into emerging markets. For five years until 2013, a lot of global growth was basically the result of emerging markets.”

Once the QE program ended in the U.S., though, “we saw a significant amount of volatility in those emerging markets.”

He called China the “big one,” citing concerns about the deceleration of its economy and “lately, the situation with their stock market.” He said that the Chinese government’s efforts to switch from an export-driven economy to more domestic-driven growth present a lot of challenges.

“They have a lot of tools and they’ve made a lot of progress,” he said, “but that has translated into excessive inventory and excessive extra output that they still need to offload.”

China’s economy was expected to grow 7%, but “they’re struggling to get to that level.”

Those challenges, combined with struggles in Brazil and Russia and a stronger dollar, it creates a “very difficult hurdle for them to continue to perform well.”

India, however, is “moving in the right direction,” he said, “but it’s only one of those main emerging markets that seems to be doing well.”

Brett Wander, chief investment officer for fixed income, addressed expectations for when the Fed will begin to raise rates.

“The Fed very much wants to raise rates this year,” he said. “They’ve been at zero basically for the last six years. They know it’s not sustainable, and even if the economy doesn’t improve significantly, they realize that zero isn’t quite the right rate.”

He said it’s likely that the Fed will raise rates this year. “It may not be September, but sometime in the fourth quarter.”

However, he stressed that just because the Fed raises the federal funds rate, it doesn’t mean all interest rates will go up. The lack of inflation in the U.S. and the divergence in central bank policies around the world will likely work to keep other rates low, he said. Ten-year Treasuries, which are at 2.35% right now, may only increase to 2.5%. At any rate, predictions of a 3% rate are overblown.

Still, Wander thinks bonds are a “still a good opportunity” right now.

Returning to Greece and its impact on fixed income specifically, Wander said, “There’s always going to be market moving events. If we’ve learned anything from history, it’s that it’s wise for investors and wise for fixed income investors to think about longer term sector and asset allocation relationships to not overreact to any given market event or market condition.”

He urged investors to maintain a long-term investment strategy using a fixed income portion “as a more conservative offset to the risks that exist on the equity side.”

He said that over the past couple of weeks, they’ve seen vulnerabilities in riskier fixed income investments, particularly high-yield securities, noting that they’ll underperform when equities do. “If anything, our recommendation is stay diversified, use a variety of sectors within the fixed income marketplace, don’t overreact and don’t look for too much aggressive additional yield from the fixed income marketplace given that you’re using a fixed income portfolio in order to offset risks.”

For individual investors with taxable assets, Wander recommended munis. “Muni yields are just about the same as they are in the Treasury market, but you’ve got the tax advantage.”

Corporate bonds are also a good opportunity, he said. “There’s a huge range within corporate bonds. There’s investment-grade corporate bonds, which are reasonably safe. Then you get to the high-yield market and those risks start to increase significantly.”

Investors who use corporate bonds, though, need do so on a diversified basis and in a fund context to preserve liquidity, he said.

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