Late rally lifts markets
A late rally helped lift most of the major indexes into positive territory for the month. The technology-focused Nasdaq Composite Index recorded a loss, however, as biotechnology stocks pulled back sharply after being among the market's top performers in 2013. The small-cap Russell 2000 Index also fell slightly. The defensive telecommunication services and utilities sectors performed best within the Standard & Poor's 500 Index, followed by the more heavily weighted financials sector. Energy and consumer staples stocks also outperformed, while consumer discretionary joined health care as the only two segments to suffer declines for the month. Value stocks handily outperformed their growth-oriented counterparts as investors shunned higher-priced stocks.
|S&P MidCap 400||0.37||3.04|
Russell Investment Group is the source and owner of the trademarks, service marks, and copyrights related to the Russell Indexes. Russell® is a trademark of Russell Investment Group. It is not possible to invest directly in an index.
1Returns are for the periods ended March 31, 2014. The returns include dividends based on data compiled by T. Rowe Price, except for the Nasdaq Composite, whose return is principal only.
2The Dow Jones Industrial Average and the Standard & Poor's 500 Stock Index of blue chip stocks, the Standard & Poor's MidCap 400 Index, and the Russell 2000 Index are unmanaged indices representing various segments by market capitalization of the U.S. equity markets. The Nasdaq Composite Index is an unmanaged index representing the companies traded on the Nasdaq stock market and the National Market System. It is not possible to invest directly in an index.
Geopolitical concerns return to forefront
After a long period of relative calm in international affairs, geopolitical concerns regained investors' attention in March. The movement of Russian troops into the Crimean region of Ukraine sent markets tumbling early in the month. Markets soon stabilized somewhat, but investors remained on edge throughout the month as Crimeans voted to secede from Ukraine and Russian troops moved into additional positions along the Ukrainian border. The U.S. and its European allies responded with targeted sanctions and the threat of additional trade actions, which further unnerved investors with the threat of interrupted energy supplies from Russia and other repercussions to the fragile economies of Europe.
China slowdown also poses threat to global economy
A sharper-than-expected slowdown in the Chinese economy also deepened concerns about the global economy. U.S. stocks fell alongside global markets early in the month after China reported a sharp drop in exports, while poor manufacturing data and other weak indicators later in the month also weighed on sentiment. In response to the slowdown, T. Rowe Price analysts anticipate that China's government will roll out growth-supporting measures, such as new infrastructure spending and looser financial policies, as it tries to meet its 2014 expansion goal of 7.5%.
Investors await spring thaw in U.S.
On the domestic front, investors eagerly awaited signs that the U.S. economy would enjoy a spring thaw after weeks of exceptionally harsh weather that appeared to weigh on auto sales and construction, in particular. A favorable payrolls report at the beginning of the month boosted markets, as did later reports of an encouraging rise in building permits and a rebound in some measures of factory activity. Stocks wavered at the end of the month, however, after reports that new home sales had declined to a five-month low, while a measure of consumer confidence dipped to a four-month low.
Buyouts of public companies boost stock prices but reduce opportunities for investors
One factor supporting stock prices during the month was the prospect of further acquisitions, both by competitors sitting on record levels of cash and by private-equity firms. Buyouts of public companies in recent years have helped boost stock prices in many instances, but they have also reduced the opportunity set for investors. T. Rowe Price Portfolio Manager Greg McCrickard notes that this is a particular challenge for small-cap investors, as the number of initial public offerings has not kept pace with the decline in listed companies. Several factors have contributed to the decline, including higher regulatory hurdles and costs for taking a company public and the ready availability of venture capital and other private funding sources.
Solid performance for emerging markets bonds stands out
Emerging markets debt was the only major fixed income asset class to post notable returns, either positive or negative. Overcoming obstacles such as slowing economic growth in China and the geopolitical tension about Russia's annexation of Crimea from Ukraine, emerging markets bonds continued to rebound from their sell-off in 2013 and at the beginning of this year.
Geopolitical tensions and growing confidence in U.S. economy move Treasury yields
Treasury yields fell sharply early in the month as a result of flight-to-safety demand after Russia's military occupied Crimea. As the month went on, anxiety about the standoff between Russia and the West appeared to diminish as investors moved back into riskier asset classes. Rising confidence in the strength of the U.S. economy in general and the labor market in particular also helped reduce the demand for Treasuries, and yields moved back up by month-end.
Uncertainty about timing of eventual Fed rate increase
Another factor that helped nudge Treasury yields higher—particularly on shorter-term Treasury debt—was Federal Reserve Chair Janet Yellen's impromptu statement about the central bank possibly raising the federal funds rate as soon as six months after ending its asset purchases. That time frame would place the start of monetary tightening earlier than markets had anticipated. In another sign that the Fed perceives that the economy is gathering momentum, Yellen expressed clear confidence in the job market, saying that "labor market conditions have continued to improve." T. Rowe Price Chief Economist Alan Levenson says that the Fed will still likely wait until mid-2015 to raise rates.
|Barclays Capital U.S. Aggregate Bond Index||-0.17%||1.84%|
|Credit Suisse High Yield Index||0.27||3.07|
|Barclays Capital Municipal Bond Index||0.17||3.32|
|Barclays Capital Global Aggregate Ex-U.S. Dollar Bond Index||-0.01||2.79|
|J.P. Morgan Emerging Markets Index Plus||1.37||3.73|
|Barclays U.S. Mortgage Backed Securities Index||-0.32||1.59|
Overcoming negative factors, emerging markets bonds continue to rally
Emerging markets bonds followed up on their strong February returns with a solid March in spite of Russia's annexation of Crimea from Ukraine. In fact, the announcement of a two-year International Monetary Fund financing package for Ukraine potentially worth up to $18 billion helped boost Ukrainian debt. On the negative side, some economic data from China were weak, which made it increasingly unlikely that the country will be able to achieve its 7.5% target for 2014 gross domestic product growth without renewing stimulus measures. Also, a Chinese solar-equipment company missed an interest payment on an outstanding bond, marking the first time that China's government has allowed an onshore, local currency bond to default. This will likely cause investors to more accurately price credit risks in Chinese corporate bonds. Developed non-U.S. market debt posted muted returns as investors sorted through mixed global economic data.
High demand for Puerto Rico's new municipal bonds
Puerto Rico issued municipal debt for the first time since its downgrade to noninvestment-grade status by all three major credit rating agencies in February. The commonwealth sold $3.5 billion of bonds in an oversubscribed offering, which should give Puerto Rico some time to concentrate on improving its fiscal situation and economy. New municipal bond issuance in general was low, and significant demand from nontraditional municipal investors helped Puerto Rico sell its new debt at a surprisingly low initial yield under 9%.
Strong issuance of corporate bonds
In contrast with the municipal market, new issuance of corporate bonds remained strong. This was particularly true early in March, when corporations rushed to take advantage of the dip in Treasury yields by selling new debt at low funding costs. Investment-grade credit spreads, which measure the additional yield that investors demand as compensation for holding a bond with credit risk versus a similar-maturity Treasury security, fell slightly over the course of the month. High yield corporate bonds, once again, outperformed investment-grade issues as the attractive relative yields of the noninvestment-grade asset class and the generally strong financial condition of high yield issuers lured investors.
|U.S. Treasury Yields|
|Maturity||February 28, 2014||March 31, 2014|
Fed tapering weighs on agency MBS
Within the securitized debt asset class, agency mortgage-backed securities (MBS) suffered from steadily decreasing demand as the Fed scales back its purchases of agency MBS and Treasuries. Before starting to taper, the central bank was buying $40 billion of MBS each month, which accounted for about one-third of the market. In March, the Fed bought only $30 billion of agency MBS.
Compelling opportunities in dollar-denominated emerging markets bonds
T. Rowe Price portfolio managers and analysts see attractive relative value in select commercial mortgage-backed securities and asset-backed securities. However, they currently view some emerging markets debt denominated in U.S. dollars as the most compelling opportunity overall. Some emerging markets bonds have sold off to levels that we believe do not reflect their intrinsic value, and debt denominated in dollars would mitigate the effects of future volatility in emerging markets currencies.
Geopolitical uncertainty rattles non-U.S. markets in March
Stocks in developed non-U.S. markets posted mixed results in March as investors closely monitored increasing geopolitical tensions in Ukraine and renewed signs of a slowdown in China. Developed European markets slightly underperformed the broad MSCI Europe, Australasia, and Far East (EAFE) Index, while stocks in the Asia ex-Japan region outperformed. Emerging markets generally fared better than developed markets. Latin American and emerging Asian markets significantly outperformed the emerging Europe, Middle East, and Africa region. The movement of Russian troops into the Crimean region of Ukraine sent stocks tumbling in early March. Most markets quickly stabilized, but Russian stocks continued their steep decline, exacerbated by weakness in the ruble versus the U.S. dollar.
Within the EAFE index, there was little distinction between the returns of growth and value shares, and large- and small-cap stocks performed similarly. Except for utilities, which advanced nearly 2%, and modest gains in energy and consumer staples, every sector in the EAFE benchmark posted a loss. The U.S. dollar strengthened versus the euro, the British pound, and the yen.
|MSCI Indexes1||March 2014||Year-to-Date|
|EAFE (Europe, Australasia, Far East)||-0.57%||0.77%|
|All Country World ex-U.S.||0.32||0.61|
|All Country Asia ex-Japan||1.01||-0.68|
|EM (Emerging Markets)||3.09||-0.37|
1Source: MSCI. MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indices or any securities or financial products. This report is not approved, reviewed, or produced by MSCI.
The largest Asian markets performed poorly
In Asia, stocks in Japan and Hong Kong were weak, but Australia, New Zealand, and Singapore posted strong gains. The Japanese government's efforts to fight deflation continued to have an impact as the core consumer price index rose in February for the ninth consecutive month. Consumption data were mixed, however, as retail sales showed improvement, while household spending was weaker than expected ahead of the scheduled April 1 sales tax increase. Slowing Chinese economic growth caused investor concern and led to selling in the world's second-largest market. T. Rowe Price analysts believe that the structural reforms announced by China's new leadership could accelerate in 2014, setting the stage for more balanced economic growth in the years ahead. The best-performing emerging Asian markets in March were India, Indonesia, Pakistan, and Thailand, each posted gains of at least 5%.
Europe's stock markets generated mixed returns
Among developed European markets, Italy and Spain performed the best as the eurozone continued to emerge from recession. Persistently low inflation remains a problem in the eurozone, where the annualized rate of inflation in February trailed the European Central Bank's target of just under 2%. Recent reports of further price declines in Spain and Germany have increased the likelihood that the European Central Bank could enact stimulus measures when it meets in early April. Nevertheless, the European macroeconomic backdrop is starting to improve, as witnessed in manufacturing and other economic indicators. Many European companies have meaningfully restructured their business operations since the sovereign debt crisis, reducing costs and improving their market positions. T. Rowe Price analysts in Europe believe that many companies will generate more revenue and earnings as the recovery gathers momentum. Among emerging markets in the Europe, Middle East, and Africa region, stocks in Turkey and South Africa generated strong returns, while shares in Egypt, Poland, and Russia declined.
Non-U.S. stocks remain attractive as longer-term growth prospects improve
In Europe, better economic data suggest that the modest recovery will continue, helped by the gradual easing of austerity measures and stronger U.S. growth. It seems that confidence is returning to European markets, and this should feed into both consumer and corporate spending. Additionally, valuations remain reasonable by several key measures, and many European companies should benefit from reducing costs and improving their market positions over time. While we remain optimistic about the longer-term prospects for Japan's market, we are looking for signs that its policymakers are politically willing and able to address important structural reforms to labor markets, tax and regulatory regimens, and social spending.
We believe emerging markets offer compelling valuation opportunities, given their strong long-term growth prospects. However, the twin tailwinds of a commodity supercycle and double-digit growth in China appear to be fading, and emerging markets are now facing a period of slower growth coupled with tighter global liquidity. These adjustments caused emerging markets to underperform in the past year, but over the longer term, we believe that the secular growth drivers for emerging markets remain in place.
Emerging markets stocks rise as currency contagion fears ease
Emerging markets stocks rose in March as currencies recovered across the developing world, easing worries about a broad sell-off early this year that threatened the stability of many countries. Currencies in Brazil, India, Indonesia, South Africa, and Turkey—the so-called "fragile five" of the developing world due to their weak fundamentals—rose 2% to 3% versus the dollar after central banks in each country raised interest rates earlier this year in a bid to stem the sell-off. Polling results favoring reform-minded opposition candidates lifted stock markets in India, Indonesia, and Brazil, all of which have elections later this year. Finally, a series of weaker-than-expected data in China raised speculation that its government will enact new stimulus measures to bolster the economy. Eight out of 10 sectors in the MSCI Emerging Markets Index rose, led by consumer staples and financial stocks with gains of at least 5%. Health care stocks declined, while information technology stocks ended nearly flat.
|MSCI Indexes1||March 2014||Year-to-Date|
|Emerging Markets (EM)||3.09%||-0.37%|
|EM Latin America||8.84||0.39|
China stocks retreat as data underscore slowdown
- China was the only market that declined in Asia as recent data raised worries that the country faces a serious growth slowdown. Two separate surveys showed that the manufacturing sector continues to struggle, February exports unexpectedly sank 18%, and other weaker-than-forecast indicators suggested that the government's 2014 growth target would be harder to reach.
- Indian shares rose the most in Asia, gaining more than 8%. The country's domestic stock index rose to a record at month-end amid optimism that the opposition Bharatiya Janata Party (BJP) will take power after national elections scheduled for April and May and push through much-needed economic reforms. T. Rowe Price analysts caution that while the BJP may win the most seats in parliament, it remains unclear if it will win enough to form a stable coalition that gives it a clear reform mandate.
- Indonesian stocks strengthened more than 5%, making it Asia's best year-to-date performer. The country's domestic benchmark reached its highest level since June 2013 after the main opposition party named the governor of Jakarta as its presidential candidate. Additionally, strong corporate earnings growth and a shrinking current account deficit have restored some confidence in Indonesia's economy.
Brazilian stocks surge after poll results
- Stocks in Brazil surged 11%, aided by speculation of more market-friendly policies after a late-month poll showed a drop in President Dilma Rousseff's approval rating ahead of presidential elections in October. Though Rousseff is expected to win reelection, a tighter race raises the likelihood of an opposition victory or that her administration will adopt more centrist policies—both of which would be welcome news for investors. Separately, Standard & Poor's cut its sovereign credit rating for Brazil to one notch above junk with a stable outlook, citing a weak growth outlook, rising debt, and widening deficit.
- Mexican stocks advanced. Its government forecast economic growth of 3.9% this year versus last year's 1.1% pace, a four-year low amid downturns in manufacturing and the home building industry. T. Rowe Price analysts believe Mexico's economy will significantly benefit from productivity gains due to sweeping reforms enacted in the past 18 months.
- Colombian stocks rallied more than 15%. The country's gross domestic product (GDP) expanded at a surprisingly strong 4.9% in the fourth quarter, bringing full-year GDP growth to 4.3%.
Russian stocks slump on Ukraine crisis
- Russian stocks fell the most among EMEA countries as investors worried that the Ukraine crisis could lead to damaging sanctions from western countries following Russia's annexation of Crimea. The domestic Micex Index touched its lowest level since 2009 before a referendum in Crimea on whether the region should join Russia. Fitch Ratings and S&P separately cut their credit rating outlooks on Russia to negative, citing the impact of sanctions on Russia's flagging economy.
- Turkish stocks soared more than 16% ahead of month-end local elections. The election results solidified the ruling AKP party's hold on power and dispelled some of the uncertainty that has weighed on Turkey since a corruption probe erupted in late 2013. Turkey's currency rallied and its domestic stock index reached its highest level since last December, erasing its losses for the year. T. Rowe Price analysts believe the elections produced the best among all bad outcomes—namely, an AKP victory with greater checks and balances due to a stronger opposition. We believe ongoing political tension and weaker reform momentum will define the outlook for Turkey, which faces ongoing uncertainty due to two more elections into 2015.
- South African stocks strengthened. The country's central bank left its key lending rate unchanged as it tries to boost economic growth, despite rising inflation spurred by currency weakness in recent months.
Solid long-term fundamentals offset near-term risks
We believe that emerging markets stocks are an attractive asset class for long-term investors, but they should invest gradually and have realistic expectations. Emerging markets may not outperform developed markets by the wide margin achieved over the past decade, but they should resume their role as global leaders over time. Stocks across the developing world are trading at a significant discount relative to their history and their developed market peers, making current valuations compelling for long-term investors. Additionally, most emerging markets today have stronger financial positions, larger foreign exchange reserves, and more flexible foreign exchange policies.
In the near term, significant risks for emerging markets include: a worse-than-expected economic slowdown in China or a breakdown in its financial system; a further rise in investors' risk aversion; and a sharp rise in U.S. interest rates due to Federal Reserve tapering, which would exacerbate capital outflows. Political uncertainties have risen in many developing countries that have elections in the coming months, although we believe that new governments in some countries will bring market-oriented reforms. In recent years, we have noted significant dispersion in the returns of emerging markets stocks even within the same country and industry. With the end of the global commodities boom and double-digit annual growth in China, we believe that careful stock selection will be increasingly crucial for long-term outperformance.