Charles Schwab: International Stocks a Way to Play Inflation in 2018

January 5, 2018 — 1:29 PM EST

Given inflation is one of the risks for 2018, Charles Schwab chief global investment strategist Jeff Kleintop says that international stocks may be a good way to play a higher-than-expected inflationary environment.

In an interview with Bloomberg, Kleintop said that international stocks have more inflation sensitivity relative to U.S. stocks, particularly from an earnings perspective. He said that companies in Europe and even more so in Japan will benefit if there is a higher-than-expected uptick in inflation as it relates to earnings per share estimates and ultimately stock prices. Kleintop noted that the global stock market rally of 2017 was tied closely to EPS estimates, and more of the same could be in the cards for 2018. (Check out Investopedia's  Charles Schwab review to learn more about this iconic broker with powerful charting tools.)

In December, the San Francisco-based discount brokerage offered up its market outlook for the new year, saying that, while a recession isn't likely this year, the markets are entering the late stages of the cycle. "We anticipate solid growth in 2018 and don't see a recession on the horizon," predicted Schwab Center for Financial Research experts in the market outlook report. "However, with markets priced for ongoing moderate growth and low volatility, the risks we're monitoring include the potential for higher inflation and more central bank tightening than expected."

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According to research arm of The Charles Schwab Corporation (SCHW), a tight labor market could boost wages, which could increase inflation. That would, in turn, prompt the Federal Reserve to raise short-term interest rates more than what is expected to keep inflation at bay. If that happens, it could result in more volatility in the stock market and thus increased risk to investors. Schwab noted that the Fed is expected to raise interest rates two or three times at a minimum this year, driven by strong economic growth, the tight labor market and the potential for tax cuts that could push inflation above the Fed's 2% target in 2018.

Against the backdrop of rising inflation and increasing interest rates, Schwab financial experts said that diversification should be a major theme for investors in 2018. They point to the fact that all of the 45 major economies tracked by the Organization for Economic Cooperation grew in 2017 and will continue to do so this year. "While risks from politics, central bank policies and military threats haven't gone away, investors have recognized that the global economy isn't as vulnerable to such things as it was in the past decade," said Kleintop said in the outlook report. "Like a giant cluster of balloons – one or two could fail – and the world's economy would remain aloft for 2018."