Monthly Market Wrap-Ups

April 2013

Most U.S. stocks trade higher in April

U.S. equity markets moved mostly higher in April, with only small-cap shares showing weakness. With bonds offering meager yields, investors continued to allocate money into larger-cap stocks in search of income and growth. Investors digested a range of economic reports suggesting that the U.S. economy is grinding ahead at a fairly weak pace. Unemployment remains high, the housing market shows signs of recovery in many areas, and inflation is subdued. Corporate earnings growth has been relatively good. The general environment has been favorable enough to sustain strong stock market returns through the year to date.

S&P sectors and growth and value segments mixed

Most S&P 500 sectors gained ground and outperformed the broad market index. The notable exceptions were energy and industrials and business services, which ended in negative territory. Telecommunication services and utilities performed best; investors were attracted to stocks with high dividend payouts in the latter group. Materials and information technology were both positive but lagged the S&P 500 Index during the month. Growth bested value stocks in the large- and mid-cap segments, while the opposite was true for small-caps, which were weak overall.

U.S. GDP growth weaker than anticipated

First-quarter U.S. gross domestic product (GDP) growth was disappointing, estimated at an annualized rate of 2.5%, according to the Commerce Department. Most analysts had been anticipating growth in excess of 3.0%. The shortfall appears to be due mainly to less business investment and a decline in government spending, as defense outlays fell sharply. Second-quarter growth is likely to be slower because of federal spending sequestration and a pullback in consumer spending, according to T. Rowe Price economists. Labor costs rose slightly, reflecting benign wage inflation against a backdrop of high unemployment. Central banks around the world have been taking different measures to spur growth. The U.S. Federal Reserve's low interest rate policy is expected to remain in place for the time being, while central banks in other developed markets are also maintaining loose monetary policies. However, we believe the major central banks are at different stages in the easing cycle.

Fed will continue its loose monetary policy, with a slight change

Following a two-day policy meeting, the Federal Reserve announced that it would maintain its program of keeping short-term interest rates at record lows until the unemployment rate falls to 6.5% and inflation accelerates. The latest reading on unemployment was 7.5% and annual consumer inflation was below 2% through the end of March. The Fed is "prepared to increase or reduce the pace" of its asset purchases "as the outlook for the labor market or inflation changes," according to a statement issued at the end of its latest meeting. Currently, the Fed is purchasing $85 billion a month in Treasury and mortgage-backed bonds as part of its effort to keep borrowing costs low and stimulate more spending. The statement reflects a slight shift in Fed guidance. It can be viewed as an outcome of earlier discussions about reducing purchases as the labor market improves. That said, the policy statement did not reveal any change in the Fed's outlook for the labor market or for inflation expectations. T. Rowe Price economists do not anticipate significant changes in Fed policy at its next meeting in June. However, there is a possibility that the central bank could begin to scale back its asset purchases as early as September. As long as the U.S. economy continues to grow at a moderate pace in an environment of low interest rates, the outlook for equities should remain favorable.

April 2013

Drop in long-term Treasury yields drives gains

Bonds saw good overall returns in April thanks to a sharp drop in long-term government bond yields as well as continuing strong demand for riskier, higher-yielding issues. Long-term Treasuries scored the strongest returns, but high yield and investment-grade corporate bonds also performed well despite slowing earnings growth and global economic concerns. Municipal bonds continued to bounce back from weaker performance earlier in the year, helped in part by the meaningful decline in Treasury yields. Mortgage-backed issues lagged a bit, as investors worried about new government efforts to boost refinancing and a possible pullback in the Federal Reserve's asset purchases later this year. Dollar-denominated emerging markets bonds were strong as disappointing manufacturing data from China and declining commodity prices raised hopes for monetary stimulus. Plans for large bond purchases by the Bank of Japan raised the prospect that Japanese investors might be pushed into buying Treasuries and other low-risk assets, also helping to bring down yields.

Another springtime slowdown?

Although mixed, April's economic data suggested that yet another springtime slowdown in the U.S. economic recovery was unfolding. Long-term Treasury yields fell sharply as first a private payroll company and then the Labor Department reported that employers had scaled back hiring considerably in March. The Institute for Supply Management also reported declines in its gauges of manufacturing and service activity, suggesting to some that recent fiscal tightening—in the form of both tax increases in January and spending cuts resulting from the sequester in March—was beginning to exert a drag on the economy. The slowdown was also evident in a pullback in retail sales and consumer confidence. News that the economy had expanded at an annualized rate of only 2.5% in the first quarter (according to advance estimates) pushed the 10-year Treasury note yield to its lowest level of the year on the final day of the month. Many had expected growth in excess of 3% as the economy rebounded from very slow growth in the final quarter of 2004.

Low inflation—below Fed's target—is helpful to consumers in the short term

One bright spot for the U.S. consumer in April was the continuing pattern of very low inflation. The Labor Department reported that energy costs had fallen by 2.6% in March, helping drive a 0.2% decline in the overall consumer price index. The so-called core index, which excludes volatile food and energy costs, rose only 0.1%, its smallest advance in several months. "Inflation has been running somewhat below the Committee's longer-run objective," the Fed noted after its most recent monetary policy meeting, "apart from temporary variations that largely reflect fluctuations in energy prices." While declining inflation poses its own set of problems for policymakers, T. Rowe Price economists note that falling gas prices, in particular, will help consumers rebuild savings in the wake of January's payroll tax hikes.

Valuations stretched but bond "bubble" seems unlikely

According to T. Rowe Price Fixed Income Director Mike Gitlin, bond valuations in many sectors are stretched, and with interest rates at such low levels, the potential for meaningful bond price appreciation is limited. We believe that investors should be aware of the prospect for rising rates. While we feel it is important to highlight the reality of interest rate risk, we do not subscribe to the cataclysmic view that a "bond bubble" is about to burst or that investors should sell all of their fixed income investments before rates rise. Interest rates are low for several reasons, including modest economic growth, high levels of unemployment, contained inflation expectations, and the actions of the Federal Reserve. Even when rates return to more normal levels, bonds will remain an important asset class, and we expect to continue finding good investment opportunities for income-seeking investors.

April 2013

International stock markets post strong gains, led by Japan

Despite heightened volatility, most developed equity markets rallied in April, adding to solid first-quarter gains. The mature markets in Europe and the Asia-Pacific region were paced by Japan's torrid advance. Overall, emerging markets produced positive returns. Among the emerging regions, stocks in Asia performed best, while equities in Latin America and Europe declined. The largest emerging markets, including Brazil, India, and China, generally outperformed their smaller counterparts. However, the Russian market fell along with oil prices. Most major currencies strengthened versus the U.S. dollar, but the yen declined for the month and is sharply lower for the year to date.

Value stocks performed better than growth stocks within the MSCI Europe, Australasia, and Far East Index, and large-cap stocks significantly outperformed small-caps. The strongest sectors within the EAFE index were utilities, financials, and telecommunication services. Although all of the sectors in the index were higher for the month, the economically sensitive materials, energy, and industrials and business services sectors lagged.

Developed European markets generated solid gains. Although business activity contracted and sentiment declined in Germany-the eurozone's largest economy-investors bid up assets on hints that the European Central Bank (ECB) was poised to cut its bank lending rate by a quarter point. (The Governing Council followed through on May 2 with a rate reduction to 0.50%.) Recent eurozone data have suggested that the region may be weakening further as a result of biting austerity measures. Germany's low purchasing managers' index reading, which generally has a high correlation with gross domestic product growth in the recession-bound region, caught many economists by surprise and appeared to undermine expectations for moderate growth in the second half of the year. The ECB's bank lending survey showed a similarly guarded stance—banks remain reluctant to lend due to economic uncertainty. Most eurozone economists agree that although the ECB's bond-buying program has eased financial tensions in the region, it has done little to boost economic conditions. T. Rowe Price's European analysts and portfolio managers expect modest economic improvement for the eurozone this year.

Performance within the Asia-Pacific region—with the exception of South Korea—was strong. The Japanese stock market powered ahead as exports increased and the Bank of Japan increased its bond-buying program at the beginning of April. Household spending in the world's third-largest economy climbed at its fastest pace in nine years, reflecting the positive effects of Prime Minister Abe's aggressive fiscal policies. Consumer sentiment and employment figures also improved. Although Japan's industrial production advanced at a slower-than-expected pace in March due to faltering demand overseas, economists forecast that exports and factory output will continue to improve. Slower growth in the Chinese manufacturing and services sectors are a significant concern. Although the Chinese market advanced in April, preliminary readings of the country's purchasing managers' index dipped to a two-month low, reflecting a slowdown in business activity.

Equity markets are benefiting from policymakers' aggressive monetary support, which is contributing to positive sentiment across many developed non-U.S. markets. Japan's market, for example, has benefited from policies aimed at arresting stagflation and lifting asset prices. Investor concerns about the European sovereign debt crisis have eased. Nevertheless, global political uncertainties remain a significant risk, particularly on the Korean peninsula. Overall, we remain optimistic on the long-term outlook for non-U.S. equities. We think that emerging markets offer a better risk/reward proposition than developed markets over the medium to long term. Given the uncertain conditions, we favor companies that generate stable growth and solid cash flow.

April 2013

Emerging markets stocks rise on continued stimulus hopes

Emerging markets stocks rose in April as investors anticipated that central banks would stick with easy money policies to support global growth. Expectations that the Federal Reserve and the European Central Bank would keep their accommodative measures intact were vindicated when each gave a policy update in early May. Loose monetary policy in developed markets has underpinned emerging markets stocks in recent months despite fresh indicators of flagging global growth. The MSCI Emerging Markets Index sank to its lowest level in almost five months after China released surprisingly weak first-quarter gross domestic product [GDP] data on April 15. The report triggered steep declines in gold, copper, oil, and other commodities. However, the index managed to bounce back by month-end as buyers took advantage of the declines.

Seven sectors rose and three declined. Health care, consumer staples, and telecommunication services led advancers with gains of at least 3%. Materials, industrials, and energy stocks accounted for the decliners. Materials have dropped the most for the year-to-date period, down more than 12%, reflecting worries that China's slowdown will sap raw materials demand.

China rises despite poor GDP data; South Korea falls amid political tension

Stocks in China advanced as the worse-than-expected GDP report raised expectations for economic stimulus from the government, which is trying to avoid an economic hard landing. South Korean stocks retreated amid rising tensions with North Korea, which has ratcheted up threats of military action over the past month, including its latest declaration of war on March 30. Still, South Korea's economy grew 0.9% in the first quarter from a 0.3% increase in last year's fourth quarter, its fastest pace in two years, as the government lifted spending. Stocks in the Philippines advanced as its domestic benchmark hit another record high in April. Philippine stocks have rallied for months on surprisingly strong economic growth and after Fitch Ratings upgraded the country's debt to investment-grade status in March. Malaysia's stock market also hit a record amid expectations that the ruling party will retain power in a tightly contested national election on May 5. Malaysia was Asia's best performer, rallying more than 4%.

Brazil advances; Peru plunges on commodities rout

Brazilian stocks rose despite the domestic Bovespa index tumbling at mid-month after China's GDP report. Brazil is struggling to revive its economy with tax cuts and other incentives while keeping a lid on inflation, which lately has exceeded its target range. The central bank lifted its benchmark rate to 7.5% on April 18, its first rate increase since July 2011. Mexican stocks retreated. Mexico's stock market reached record levels early this year amid reform hopes of its new president, but its economy has recently showed signs of slowing with some weaker-than-expected first-quarter indicators. Peru was Latin America's worst performer, down more than 11%, driven by the sell-off in copper, one of the country's chief exports.

Turkey rises after rate cut; Russia falls on oil weakness

Stocks in Turkey gained. Turkey's central bank cut its benchmark lending rate by an unexpectedly large half percent to 5% on April 16 in an effort to boost growth against weak global demand. Russian stocks fell more than 2%, the most in the EMEA region, as the country struggles with falling crude oil prices, slowing consumer spending, and rising inflation. Russia's government slashed its 2013 growth forecast to 2.4% from a previous 3.6% estimate, and the government said it's likely the country has already fallen into recession. T. Rowe Price analysts believe that the end of oil-driven growth in Russia could spur the government to implement reforms to improve the business climate, though entrenched interests in government and business make major changes unlikely in the near term.

Outlook for long-term growth is intact despite near-term volatility

We expect that developments in Europe, slowing growth in China, and unresolved fiscal problems in the U.S. will drive volatility in emerging markets stocks in the coming months. Emerging markets stocks have underperformed U.S. stocks in the year-to-date period, and recent fund flow data show investors have retreated from developing markets stocks as their returns have lagged. As a result, valuations for developing markets stocks have become increasingly attractive relative to developed markets stocks in recent weeks. We believe that markets are pricing in many of the near-term risks for the asset class. Over the medium to longer term, we remain optimistic about the growth outlook for emerging markets. We believe that increasing consumption, a growing middle class, rising real wages, and greater upward mobility will drive strong and sustainable growth across the developing world over time.