April 25, 2012
A strong first-quarter rally brought U.S. equity markets close to their 2007 highs. Jeff Rottinghaus, manager of the T. Rowe Price U.S. Large-Cap Core Fund, recently discussed the factors that have driven this surge. He also shares his perspective on the economic environment, which sectors his fund favors, and what risks investors should be keeping in mind.
The S&P 500 rose more than 12% in the first three months of 2012, its best quarter in more than a decade. Rottinghaus attributed this upswing largely to two factors: a debt deal to help resolve the European Union fiscal crisis and improved U.S. economic data, as unemployment shrank and industrial production grew.
He notes, however, that the market has reacted negatively whenever the various economic stimulus programs wear off. Rottinghaus expects that the Federal Reserve may introduce another round of "quantitative easing" later this year with the goal of avoiding a big market drop like the ones seen in 2010 and 2011. "Eventually, this has to be self-sustaining," Rottinghaus says, "but I'm not sure that the government officials think we're quite there yet."
Rottinghaus considers large-caps to be a good value compared with small-caps, which have performed better in recent years. "As we progress through this economic cycle, and we're three-plus years into it, it's natural that you would see large-cap companies perhaps start to outperform small-cap companies," he says.
Technology is the leading sector in the T. Rowe Price U.S. Large-Cap Core Fund's portfolio, primarily due to Apple, its largest holding. While acknowledging that Apple's astronomical growth rates of the past couple of years are not likely to continue, Rottinghaus remains bullish on the company for the long term. Consumers are still gravitating toward their iPhones and Macintosh computers, he says, and the dominance of the iPad among tablets is expected to continue.
Rottinghaus sees value in large pharmaceutical companies, which he says are trading cheaply because of concerns about patents that are set to expire. With many new products in their pipelines, he believes these companies will be able to deliver solid cash flows. In the industrials and business services sector, Rottinghaus favors commercial aerospace companies, given that airlines in emerging markets are looking to expand their fleets and those in developed markets want to refresh their inventory with newer, fuel-efficient models.
In the midst of an election year, Rottinghaus notes that one potential risk to the financial markets would be an increase in taxes, either through the expiration of the Bush tax cuts or other legislation. It's uncertain whether any tax hikes might include changes to capital gains or dividend tax rates, so it's not yet clear what the impact on investors may be.
Overseas, the main areas of concern Rottinghaus sees are whether China can negotiate a "soft landing" for its overheated economy and whether Europe's debt problems can be resolved without triggering another financial crisis. He's optimistic on the measures taken by the European Central Bank. "They've taken the right steps, but I think these are longer-term issues that these countries are going to have to face, and you're going to have to see slower growth ahead…in order to solve the fiscal issues that they're facing right now."
Stocks and sectors may not perform in line with the managers' expectations. Stocks with growth characteristics can have sharp price declines as a result of earnings disappointments. Stocks with value characteristics carry the risk that the market will not recognize their intrinsic value for a long time or that they are actually appropriately priced at a low level. In addition, the U.S Large-Cap Core Fund's fairly concentrated portfolio means poor performance by several fund holdings could affect the fund more than a fund holding a larger number of companies.