For 2023, Diversification Is Back, and So Is Volatility: Schwab's Kleintop

Stocks with immediate cash flows, so-called short-duration stocks, have also outperformed, according to the firm, which noted that “the lower the price to free cash flow, the higher the quality.”

Schwab early this year shifted to a bias toward international stocks, which have outperformed U.S. shares this year for the first time in about a decade. International stocks tend to possess characteristics like high dividends and lower price-to-cash-flow ratios, Kleintop said. “Earnings growth is also looking stronger outside the U.S. for the first time in a long time,” he said.

A decline or stability in the dollar might fuel even higher outperformance for international stocks next year, according to Kleintop, who noted European stocks have gained 25% in the fourth quarter, their biggest leap ever.

While the firm recommends investors rebalance toward international stocks after a decade of U.S. outperformance, it isn’t overweight in them, Kleintop noted. Schwab recommends people allocate 30% to 50% of their portfolios to international stocks, which is higher than most investors have, he said. 

China’s reopening poses a risk for a rebound in inflation for commodities and goods globally driven by pent-up demand from 1.4 billion consumers, according to Schwab, which doesn’t expect the country to fully reopen before winter’s end.

The nature of the current economic downturn is different from the 2020 recession and the Great Financial Crisis, Kleintop said. “Those were the everything, everywhere, all-at-once recessions” and it was obvious when the economy bounced back, he explained. “That isn’t true this time,” as some parts of the economy are flourishing and others are doing poorly, he said.

Manufacturing is in a slump now, a recession, because inventories are high, “yet the service sector is still booming,” Kleintop said.

Kleintop expects to see conflicting data points probably through the first half of next year. Perhaps in the second half it will become clear that the U.S. economy is in a recovery, he added. Inflation will feel elevated and should boost stocks and bonds if it comes down, he said.

The strategist believes bond rates have peaked and are headed lower; he’s looking for positive returns in 2023 after the worst year for bonds in half a century.

Supply chain issues and war in Ukraine led to a lot of this year’s volatility and should ease over the next year, barring unforeseen developments, according to Kleintop, who said China’s reopening is his biggest focus now.

“Other than that I think things go better,” he said.