October 22, 2013

After a solid start, global equity markets stumbled through the spring and summer. The news that the U.S. Federal Reserve would consider tapering its monthly asset purchases pressured global markets heavily, but September brought a rebound when the Fed decided to hold off. Scott Berg, who has been with T. Rowe Price since 2002, has been at the helm of the T. Rowe Price Global Large-Cap Stock Fund for the last five years. In a recent interview, he discusses the Fed's global impact and the outlook for global markets.

Emerging Markets Investors Consider New Strategies

Berg notes that Fed policy has had a marked impact on global equity markets over the last five years generally, and the tapering conversation caused serious disruption in emerging markets specifically. Stocks, bonds, and currencies in emerging markets all fell over the spring and summer, some by double-digit percentages. But Berg sees these events in a longer-term context. Since the worst of the global financial crisis in October 2008, emerging markets and the U.S. market have posted similar returns.

With that said, slowing economic growth in China, a global commodity sell-off, and other factors have complicated emerging market investing. Many investors are choosing to get exposure to emerging markets through developed market companies that do business in developing markets. Berg says this can be a good strategy for the BRIC countries (Brazil, Russia, India, and China). However, it doesn't work for some countries with promising opportunities, like the Philippines, Nigeria, and Peru, so direct exposure to these markets is still a good choice.

U.S. Still Well Positioned to Lead Performance

U.S. markets are having their best year since 1977. While drawn-out political wrangling has the potential to disrupt markets, the U.S. appears to be focusing on the long-term structural positives. For example, the U.S. has a flexible labor market and a history of innovation. Part of the success in the U.S. can be attributed to a proactive Fed, but Berg says earnings are the real story. The Fed's quick and decisive action at the beginning of the crisis helped U.S. earnings recover, as has a weaker dollar resulting from extensive quantitative easing. Also, U.S. corporations have been flexible and able to reduce costs by cutting back their workforces.

On the political front, countries that own lots of U.S. debt, like Japan and China, have been concerned about the debt ceiling controversy. However, their worries would be worse if the U.S. were on an austerity path or still contributing to a global slowdown. Additionally, there are not many viable alternatives to U.S. debt.

Japan Sets the Stage for a Comeback

The Japanese market is up by a double-digit percentage so far this year in U.S. dollar terms, and investors are taking notice after largely ignoring the market for about 20 years. Prime Minister Shinzo Abe has started an aggressive program of fiscal stimulus and structural reforms, including an increased sales tax. Action and clarity have given Japanese businesses and consumers confidence, spurring some domestic inflation and creating domestic investment opportunities that did not exist before. Prior investment in the Japanese market has been concentrated on exporters. Additionally, Japan's venture into quantitative easing has weakened the yen, making the country's exports more competitive globally.

Berg says that Japan's near-term prospects look good, while the medium and long terms are murkier. Japan's demographic trends and corporate culture will be more difficult to adjust and are hurdles to long-term recovery. If Japan can reengage women in the workforce and make immigration a positive force, those steps would help. Also, Japan's corporate culture is not particularly shareholder focused. Still, compared with the last 20 years, Japan now has a decisive leader with broad popular support and a new plan.

Europe Still Struggling

After 18 months of economic contraction, Europe seems to be emerging from its deep recession. Berg concedes that Europe has stopped getting worse, although a combination of economic stagnation and huge levels of government debt continue to hold the region back. However, social unrest persists as a result of high unemployment, especially for youth. He believes Europe may be in a period of five to 10 years of economic stagnation. The European markets are no longer undervalued, and corporate earnings need to grow. European stocks have only returned to 60% to 65% of pre-crisis earnings levels, lagging other regions.

Part of the problem is the lack of clear decision-making authority resulting from the euro structure. High levels of sovereign debt remain a concern. The euro is still relatively strong, while in the U.S. and Japan quantitative easing has weakened the dollar and the yen and made exports more competitive. Europe is diverse, though. There are solid luxury goods companies in France, Italy, and Switzerland, as well as industrials in Germany and Sweden. Berg says that companies with cheap valuations are not undervalued but challenged, and the companies that are doing well are doing so in global markets, not domestic ones. The situation in Europe has stabilized but still has a long path to true improvement.

The fund is subject to market risk, including possible loss of principal. Since the fund invests overseas, its foreign holdings could be affected by declining foreign currencies or adverse political or economic events.

The views are as of October 3, 2013, and may have changed since that time. This information is provided for informational purposes only and is not intended to reflect a current or past recommendation or investment advice of any kind. Opinions and commentary do not take into account the investment objectives or financial situation of any particular investor or class of investor. Investors will need to consider their own circumstances before making an investment decision.