July 30, 2012
|Ray Mills, manager of the T. Rowe Price Overseas Stock Fund|
The equity markets have displayed substantial volatility over the last 18 months, reflecting investor uncertainty about the persistence and severity of worldwide economic turmoil. Ray Mills, manager of the T. Rowe Price Overseas Stock Fund, discusses these trends but argues that there are potential investment opportunities in the existing climate.
International developed markets enjoyed double-digit gains in the first quarter of 2012—the best first-quarter performance in more than 10 years—but faltered badly in the second quarter. According to Mills, blame for this shift rests squarely on investor concerns about the seemingly endless European sovereign debt crisis.
The ongoing fiscal challenges in the region have been a major contributor to volatility. Economically, they have contributed to widespread unemployment and shaky federal budgets. Finding lasting solutions will not be easy and will require extensive negotiations and unpopular concessions. With so much unresolved, investors have often been more comfortable waiting on the sidelines.
The problems present in the current global economy do not end with the eurozone. Economic growth is slowing in China, as well as in India and Brazil. Mills notes that people have gotten used to these nations growing at high-single-digit or even double-digit rates, and this change of pace is giving investors pause.
Since China is the world's second-largest economy, its slowing growth is a major concern to investors. Mills states that the nation's economy could face a hard landing, but the odds of that happening are low as the country's government has a wide range of policy tools it can use to fight an economic slowdown. The nation has some of the world's largest foreign exchange reserves, which total roughly $3 trillion. The government has wide flexibility to stimulate the economy since it has little debt.
Mills argues that because investors are focusing on global economic problems, they aren't always seeing the positive developments occurring in global corporations. In general, he says, corporations are in solid shape. They have made substantial progress in reducing debt loads and costs and boosting competitiveness. Companies have been generating strong profits and are ready to expand given the right operating environment.
Moreover, market declines have enhanced the attractiveness of stock valuations in many markets. Valuations of U.S. companies are historically low, with the S&P 500 Index trading at around 13 times earnings versus the 50-year average of 16.2. Outside the U.S., says Mills, valuations are even lower, with stocks in developed markets trading broadly at around 10 times earnings. There are many equities with dividend yields around 4%—a significant premium over some U.S. bond yields.
To take advantage of these opportunities, Mills seeks developed market companies with great management teams, good corporate governance, strong brands, and appealing valuations. He currently prefers markets in northern Europe and leans toward companies that are fundamentally strong or well positioned to sell to emerging markets.
Stocks and sectors may not perform in line with the manager's expectations. All funds are subject to market risk, including possible loss of principal. Stocks with growth characteristics can have sharp price declines as a result of earnings disappointments, and those 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. Funds that invest overseas generally carry more risk than funds that invest strictly in U.S. assets, due to factors such as currency risk, geographic risk and emerging markets risk. Because of the concentration in rapidly developing economies, investing in emerging markets involves a high degree of risk. Diversification cannot assure a profit or protect against loss in a declining market.