| 30 June 2010

Between them they are the responsible caretakers of roughly $3 trillion in customer assets under management in 14 million brokerage accounts. But what’s most unique about Schwab and Fidelity is that their accounts are dominated by smaller, self-directed investors making individual and unique decisions about their investment portfolios. While they rely on a whole host of information sources and influencers to help them make their investing decisions, there is a common denominator that touches all 14 million accounts: the internal market prognosticators.

For their views, we turn to Schwab’s Chief Investment Strategist, Liz Ann Sonders, who shares her team’s insights once a month in a Webcast, and with these slides, and to Fidelity’s Market Analysis, Research and Education Group which is run by VP Dirk Hofschire, who shares his views in these slides.

Their views matter. They have the financial bully pulpit, as it were, and we thought it would be interesting to compare and contrast their most recent insights to see just how much they were aligned and where, if anywhere, they differ.

In the interest of space, and your time, the methodology we’ve chosen here is to break down their long and detailed explanations into a few bullet points on the big topics that matter. It’s worth noting that these opinions and insights were published about two weeks ago, and a lot has changed in the markets since then, which we think is telling. But our goal is not to grade their performance, but rather to look for congruencies and abnormalities that might help individual investors know what to look for in the coming months. For simplicity’s sake we’ll refer to their viewpoints as “Sonders” and “Hofschire.”

U.S. Economic Recovery

Sonders and Hofschire both point to Leading Economic Indicators (LEI) as a sign that the economy is recovering, but that the “easy period” may be over. The annual rate of change in the LEI index hit new highs recently. But cautious optimism persists. Sonders points to the fact that unemployment, building permits and stocks in particular continue to struggle, contributing to “heightened volatility.”

Employment

Both Sonders and Hofschire are optimistic on improvements to employment trends. Hofschire sees trends turning positive as certain leading indicators of employment, such as an increase in temporary employment and a decrease in initial jobless claims, continue to improve. Sonders agrees and dismisses the notion that continued unemployment could lead to a “deep recession” and instead refers to her oft-used analogy of a “coiled spring” for employment.

Deficit

Sonders is clearly more concerned about the U.S. deficit than Hofsschire and his group. Sonders points out that at current deficit levels it has taken over $5 of deficit spending to produce $1 of GDP. In fact, interestingly, both prognosticators point to the same study conducted by Rogoff and Reinhart. When debt rises above a 90% of GDP threshold, they determined, GDP begins to suffer. We’re currently at 93%. Hofschire insists, however that we are no Greece. We haven’t seen an increase in borrowing costs, as Greece has, says Hofschire. The U.S., he says, should be able to grow enough to keep pace with debt levels, whereas Greece’s debt burden will soar north of 100% of their GDP by 2011.

Inflation vs. Deflation

Both Sonders and Hofschire remain neutral on inflation, which is to say they’re not concerned about inflation becoming a threat, especially as stocks continue to keep pace with inflation. Sonders, however, remains concerned about deflation. Hofschire doesn’t address deflation at all.

Bonds vs. Stocks

Both Sonders and Hofschire remain bullish on bonds. Sonders points to the fact that stock prices and bond yields are positively correlated stocks typically lead the economy out of a recession. “Bull markets are often born in recessions,” she says. While stocks have already drifted back to their “norm” and P/E levels are in a market “sweet spot,” bonds, she says, are lagging. Both feel the market is “healthy.” Hofschire agrees that P/E levels, though they appear to be somewhat higher, are actually “in the neighborhood of average valuation versus history.” Hofschire takes care to point out that bonds reduce volatility in a portfolio and that the “worst bond periods always outperform the worst stock periods.” A 50/50 allocation of stocks vs. bonds in a portfolio cuts the volatility in hat portfolio by half. And speaking of volatility…

Uncertainty and the VIX

Sonders feels that volatility spikes in the VIX often come at t time when markets hit short-term lows. We experienced a big spike in early to mid-2009 and we’re in the midst of a spike now. “Uncertainty is rampant,” says Sonders. She also points to a dramatic drop in investor sentiment recently. Hofschire does not address volatility or the VIX directly in his comments.

Bottom Line Recommendations

Sonders weighs heavily on the uncertainty in the markets and recommends investors start by focusing on asset allocation. There exists “divergent views” and “uneasiness” on Wall Street, she says, which should results in range-bound trading through the summer. Sonders’ view is that we’ve hit a “soft patch” in the economy but that the jobs picture will improve as we head into fall. Sovereign debt issues remain in Europe, but for the most part, she says, the big threats have subsided. Her biggest concern is global deflation and a double-dip recession in Europe.

Hofschire and his team are first and foremost concerned that the financial problems in Europe will spoil U.S. confidence, which was improving thanks to recent surveys pointing to increased hiring and capital spending plans. He points out that investors should not be concerned about finding a low-point in a 10-year cycle. Rather, he insists, investor benefit by being appropriately allocated even one year before or after such a cycle. While Treasury bonds are safe, they barely outperform inflation over the long term, says Hofschire. While stocks experience significantly more volatility, they have “rewarded investors with the most significant gains over an extended period.”

Our Take

Given what we know about market commentators, whether they’re full of fluff or basing their analysis on academic research, one thing is certain: there will be a difference of opinion. And we must admit, we expected to see some differences of opinion between Schwab’s Sonders and Fidelity’s Hofschire. But aside from Sonder’s concerns about deflation, which Hofschire simply didn’t address, their opinions were almost identical.

In hindsight, it should come as no surprise that they offer similar viewpoints. Their firms must be very careful to maintain assets and grow at least on pace with the markets. So their “opinions” are based primarily on a regurgitation of classic indicators, economic reports and historical analysis. In the end, their suggestions sound like the standard playbook offered to a first-year broker: diversify, allocate assets appropriately, and stay invested in stocks if you want to outperform inflation.

Of course, the problem with such advice is that it’s always right until it’s wrong. Consumer spending just took a hit a few days ago and sent the markets into another tumultuous single-day drop. This ‘new’ news will, we estimate, force the prognosticators to reevaluate their “cautiously optimistic” analysis with more “pessimistically prepared” statements.

By not offering more specific advice they don’t do their clients a disservice – but they don’t necessarily do them a service either.