Schwab's Kleintop says advisers should ride market momentum shift

Inverted yield curves provide a message about which stock sectors are likely to perform best going forward

Nov 5, 2019 @ 12:01 am

By Jeff Benjamin

Instead of fearing the idea of an inverted yield curve, financial advisers should embrace it as an opportunity to rebalance and take advantage of what the financial markets are offering.

The strategy, which goes against the grain of popular concerns about inverted yield curves forecasting looming recessions, was laid out Monday evening by Jeffrey Kleintop, chief global investment strategist at Charles Schwab Corp., during his opening keynote presentation at the Schwab Impact conference in San Diego.

While seeing yields on longer-term bonds fall below those of closely watched shorter-term bonds historically has signaled a recession on the horizon, which Mr. Kleintop is not ruling out, data from the past four periods of inverted yield curves also show there's potential to ride some waves of markets in transition.

[Recommended video: Schwab's Jeff Kleintop: Prep for volatility given China trade uncertainties]

Looking at the past four incidents of inverted yield curves — in 1989, 2001, 2007 and 2019 — Mr. Kleintop highlighted a less talked about change in the momentum for growth versus value stocks, large-cap versus small-cap stocks, and U.S. versus international stocks.

In every instance, the inverted yield curve marked a momentum turning point that Mr. Kleintop said financial advisers should be adjusting for in client portfolios.

"A yield curve inversion says something important about the long term, because the market is reassessing its growth aspects," he said. "The last few months we've started to see value outperform growth, and I think it's for real."

While growth stocks have enjoyed a prolonged strong performance run relative to value stocks, the transition that began in September to favor value has not let up, which is something investors haven't seen in their portfolios in almost a generation, Mr. Kleintop said.

"This is important because it will remind your customers why you diversify and why you rebalance," he said. "This is part of a longer-term trend that most investors are going to miss."

Similarly, larger-cap stocks are starting to gain momentum over smaller-cap stocks, and international equities are rebounding over U.S.-based stocks.

Both Mr. Kleintop and Liz Ann Sonders, Schwab's chief investment strategist, said much of the investing community is overly fixated on the Federal Reserve, which recently cut interest rates for the third time this year.

Contrasting the stock market this year, which is up about 20%, to last year, when stocks posted a 20% drop during the fourth quarter, Mr. Kleintop said the only thing that changed was the shift in Fed policy from potentially raising rates to actually cutting rates.

"The Fed went from going up to going down, and investors are thinking central bankers are guardians of the economy," he said. "But central bankers have one super power, and that's to lower rates. Look at Germany, where rates are negative and their economy is almost in recession."

Ms. Sonders agreed, saying, "The Fed is not the elixir for what ails us."

"Historically, after the Fed has cut three times, two or more cuts after that is usually because we're heading into recession," she said.

Ms. Sonders underscored that even though this is the longest and weakest economic recovery since World War II, she remains bullish on stocks.

"We may be starting to see some frothiness as one of the risks as far as the markets go," she said. "But we recommend you stay at normal long-term allocations and overweight large caps."

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