Large-cap stocks decline; small-caps see gains
The large-cap benchmarks declined for the month. Early positive economic signals raised fears of higher interest rates, but more mixed data later in the month caused investors to grow increasingly worried about the negative impact of the strong U.S. dollar on economic growth and corporate profits. The technology-heavy Nasdaq Composite performed a bit better and managed to pierce the 5,000 level for the first time in 15 years before retreating. Helped by their lower reliance on foreign markets, smaller-cap stocks outperformed large-caps. The health care sector was a standout performer, thanks in part to corporate merger activity, and was the only sector of the Standard & Poor's (S&P) 500 Index to register a gain for the period. Materials and telecommunication services shares performed worst.
|MSCI Indexes||March 2015||Year-to-Date|
|S&P 500 Index||-1.58||0.95|
|S&P MidCap 400 Index||1.32||5.31|
|Russell 2000 Index||1.74||4.32|
Past performance cannot guarantee future results. This chart is shown for illustrative purposes only and does not represent the performance of any specific security.
Economic concerns take center stage
Stock prices fluctuated for much of the month, with economic concerns appearing to play a larger role than company-specific factors in driving market action. Early in the month, investors seemed to be preoccupied with worries that labor market strength would cause the Federal Reserve to signal a coming change in monetary policy, even if an imminent increase in interest rates was unlikely. Stocks sold off sharply on March 6 following news that employers had added nearly 300,000 jobs in February—an especially strong showing given harsh winter weather in the East and reports of widespread layoffs in the energy sector.
Weaker economic data raise hopes for Fed "patience"...
More mixed economic data later in March suggested that the Fed might stay its hand, however. Stocks rallied after the government reported a surprising decline in retail sales in February, and again following news that manufacturing output declined for the third straight month. Hopes for continued easy monetary policy were vindicated somewhat following the Fed's mid-month policy meeting. Although the Fed dropped the reference in its official post-meeting statement to remaining "patient" in guiding rates higher, Fed Chair Janet Yellen clarified at a later press conference that doing so "doesn't mean we are going to be impatient." Fed officials also lowered their expectation for rates at the end of the year due to somewhat lower growth projections.
...but also stoke fears about corporate profits and U.S. competitiveness
Investors' perspectives appeared to shift later in the month, however, as many seemed to grow more worried about the implications of a slowing economy for corporate profits. Stocks fell sharply following news of another decline in durable goods orders, and reports of slowing business activity in the manufacturing-heavy Midwest may have contributed to another leg lower for the market on the last trading day of the month. T. Rowe Price Chief U.S. Economist Alan Levenson notes that severe weather and port disruptions on the West Coast have recently weighed on manufacturing output, but he also believes that the stronger U.S. dollar may be to blame—both by reducing exports and dragging down capital expenditures by U.S. multinational firms.
Strong dollar weighs heavily on large-caps
T. Rowe Price analysts observe that the strong dollar is taking a disproportionate toll on the earnings of the large-cap companies in the S&P 500, which get well over one-third of their revenues from overseas. In contrast, the small-cap companies in the Russell 2000 Index source roughly one-fifth of their revenues from foreign sales. In the final quarter of 2014, small-cap companies enjoyed more than three times the earnings growth and over five times the sales growth of their large-cap counterparts.
Increased volatility presents opportunities for patient investors
T. Rowe Price investment analysts also note that the CBOE Volatility Index—a measure of expected volatility for the S&P 500 also known as the "investor fear gauge"—is approaching its historical average after dipping to atypically low levels in recent years. Because heightened volatility creates more opportunities to buy and sell stocks at attractive prices, we believe its recent uptick may create opportunities for long-term investors. The increase coincides with gauges showing falling correlations in the stock market, which may heighten the importance of careful stock selection.
Fed policy statement and data projections reassure investors about pace of tightening
Bonds issued by developed market governments in the eurozone and the U.S. rallied as the European Central Bank (ECB) kicked off its purchases of sovereign debt and the outcome of the Federal Reserve's March policy meeting convinced many investors that the Fed is in no rush to tighten monetary policy. The U.S. central bank removed the word "patient" from its post-meeting statement about the timing of its first interest rate hike, paving the way for it to raise rates. However, T. Rowe Price Chief U.S. Economist Alan Levenson notes that the Fed's newly released projections for economic growth and inflation were both lower than the central bank's forecasts from December, likely justifying a slower trajectory of rate increases.
ECB begins sovereign debt purchases, pushing some yields below zero
Even though Treasury yields fell, they were significantly higher than the yields available on developed market eurozone government debt, helping to further boost demand for Treasuries. (Bond prices and yields move in opposite directions.) Yields on German government bonds were below 0.00% for maturities up to eight years. The central bank will buy bonds with negative yields, says ECB President Mario Draghi, as long as they are above the ECB's -0.2% deposit rate. At the end of the month, the yield on the 10-year German government bund was 0.18%, while the 10-year Treasury note yielded 1.94%.
Strength in the U.S. dollar endures
The U.S. dollar's remarkable strength against most other currencies continued in March, dragging returns on non-U.S. developed market debt well into negative territory for U.S.-based investors. The dollar's gains stemmed from the global divergence in monetary policy direction, with the Fed preparing to raise rates even as many other central banks rush to make their policy even more accommodative. The euro/U.S. dollar exchange rate reached $1.05 per euro in March, approaching parity. The last time that the dollar and the euro were equally valued was when the currency first entered circulation in 2002.
|Barclays U.S. Aggregate Bond Index||0.46%||1.61%|
|Credit Suisse High Yield Index||-0.44||2.59|
|Barclays Municipal Bond Index||0.29||1.01|
|Barclays Global Aggregate Ex-U.S. Dollar Bond Index||-2.08||-4.63|
|J.P. Morgan Emerging Markets Bond Index Global Diversified||0.22||2.01|
|Barclays U.S. Mortgage Backed Securities Index||0.37||1.06|
Locally denominated emerging markets debt lags
Emerging markets bonds denominated in U.S. dollars generated modestly positive returns. The central banks of China and India both lowered their benchmark lending rates to stimulate growth. Near the end of the month, the prices of bonds issued by Petrobras, Brazil's state-owned oil company that is embroiled in a corruption scandal, climbed after regulators approved the firm's method of accounting for bribes. The ruling should allow Petrobras to file financial reports by the end of April to avoid a technical default. However, emerging markets debt denominated in local currencies dropped significantly as most emerging markets currencies fell against the dollar. For example, by mid-March, the Brazilian real had lost about 15% against the greenback in 2015, although it recovered somewhat later in the month.
Heavy issuance and volatile oil prices weigh on high yield bonds
Most U.S. fixed income sectors posted positive but muted returns and slightly underperformed Treasuries. However, high yield bonds lost ground amid heavy issuance and volatile oil prices. Bonds from oil-related issuers account for a large proportion of most high yield indexes, so their price weakness weighed on the asset class. Valeant Pharmaceuticals International issued $10 billion in high yield bonds to finance its acquisition of Salix Pharmaceuticals, and the outlook for an ongoing stream of new supply broadly dragged down investor sentiment.
Resilient market for investment-grade corporate debt
Issuance of investment-grade corporate bonds also continued to boom, but that market proved more resilient in the face of the new supply and was broadly able to generate gains. Pharmaceutical company Actavis sold $21 billion of debt, the second-largest corporate bond offering ever, to fund its acquisition of Allergan, maker of Botox. In Europe, French utility GDF Suez issued €500 million of investment-grade notes with a 0% coupon, becoming the first company in more than 14 years to sell euro-denominated debt with no regular interest payments.
|Maturity||February 28, 2014||March 31, 2015|
Muted returns for MBS
Mortgage-backed securities (MBS), which typically trade in lock step with Treasuries, posted muted positive returns. MBS continued to recover from selling pressure at the beginning of the year, when falling mortgage rates triggered expectations for increased levels of residential mortgage refinancing, which causes prepayments on MBS and lowers their value. The expected wave of prepayments failed to fully materialize.
Rally in Treasuries supports municipal debt
Municipal bonds generated gains despite a resurgence in new issuance, as investor demand for the supply reaching the market was generally strong. The University of California brought nearly $3 billion of new municipal debt to market in the middle of the month during a week when total issuance was $12 billion. Municipal debt prices, which also tend to track trends in the Treasury market, benefited from the rally in Treasuries.
Longer-term relative value in locally denominated emerging markets bonds
Although we expect ongoing near-term volatility in emerging markets currencies as markets adjust to the Fed's tightening plans, we think that some emerging markets debt denominated in local currencies offers compelling value for the medium to long term. The dollar may not have much more room to strengthen against the currencies of many developing markets, some of which now appear to be poised for a rebound. At the other end of the risk spectrum, some short-maturity asset-backed securities should benefit from the strengthening U.S. economy and provide solid relative value as alternatives to cash.
Asian markets buck March's global stock market malaise
Developed non-U.S. stock markets posted a loss in U.S. dollar terms for March as measured by the MSCI Europe, Australasia, and Far East (EAFE) Index following an impressive 6% rally in February. For the month, the local currency return for the EAFE index was 1.40%, which reflects ongoing U.S. dollar strength. The euro and the British pound declined sharply versus the U.S. dollar, while the yen was modestly weaker. An appreciating U.S. dollar detracts from dollar-based returns for investors holding local currency securities. Indeed, the U.S. Dollar Index—a yardstick for measuring how the greenback is faring relative to the world's other major currencies—climbed above 100 in mid-March, its highest level since 2003. The dollar is up more than 11% versus the euro so far this year and could reach parity with the euro by the end of the year, according to several forecasters. Most developed markets posted gains in local currency terms. Within emerging markets, Asia's markets generated a small gain, while Latin America and the Europe, Middle East, and Africa region recorded losses. Among the largest emerging markets, stocks in Brazil, India, and Russia declined, while those in China posted a gain. China's restricted A shares market posted a double-digit return and is up more than 90% for the past 12 months.
|MSCI Indexes||March 2015||Year-to-Date|
|EAFE (Europe, Australasia, Far East)||-1.43%||5.00%|
|All Country World ex-U.S.||-1.54||3.59|
|All Country Asia ex-Japan||0.42||4.90|
|EM (Emerging Markets)||-1.40||2.28|
In the MSCI EAFE Index, large- and small-cap stocks performed similarly for the month and year to date. Growth stocks modestly outperformed value stocks in March and for the year to date. Sector performance in the index was mixed. The energy and materials sectors tumbled in March. The energy sector fell nearly 5% and 23% for the past three and six months, respectively. The best-performing sectors were information technology and health care, with gains of about 2%. The financials sector was flat, and all other sectors posted losses.
Japan emerges from its brief recession
Although Japan's economy emerged from a six-month, tax increase-induced recession in the fourth quarter of 2014, two-thirds of Japanese business leaders plan to reduce capital investment according to the "Tankan" business survey released by the Bank of Japan (BoJ) at the end of March. The central bank is pumping trillions of yen into the economy in an attempt to suppress interest rates, stimulate inflation, and keep the yen weak versus other currencies. Japan's fourth-quarter economic growth rate was revised to 1.5% from the original estimate of 2.2%, which may force the BoJ to deploy additional stimulus measures later this year to meet its 2% inflation target. The central bank's efforts to increase inflation remains challenged by weak consumer demand and falling energy prices. Thus far, Tokyo's mix of monetary policy and economic reforms has yet to drive growth in corporate earnings, wages, and business investment.
China's economic growth and inflation declined more than expected, said People's Bank of China's (PBoC) Governor Zhou Xiaochuan. Preliminary first-quarter data showed that China's economy continued to slow after its weakest expansion (7.4%) in more than a decade last year. The PBoC reduced lending and deposit interest rates in March due to concerns about slowing economic growth, deflationary pressures, and a capital exodus that is squeezing bank lending capacity. The central bank also lowered the minimum down payment requirement for second-home buyers in an effort to bolster the property market.
ECB actions set the stage for eurozone recovery
To spur inflation and bolster tepid economic growth, the European Central Bank (ECB) launched a massive quantitative easing (QE) program in March, similar to the stimulus programs previously enacted by the U.S. and UK during the global financial crisis. The result has been near-record-low bond yields and a currency devaluation that has cheapened domestically made goods for foreign buyers. Oil prices have fallen about 50% since mid-2014, lowering costs for oil-intensive manufacturers and increasing consumers' purchasing power. Stocks in Europe declined in March but advanced almost 12% in local currency terms in the first quarter.
Although T. Rowe Price sovereign analysts think that the QE program alone will not solve the eurozone's entrenched problems, it should help the 19-nation bloc produce better growth in the second half of 2015. T. Rowe Price portfolio managers think the ECB's action will encourage investors to increase allocations to riskier assets. The move should also support corporate investment as companies issue bonds to take advantage of low interest rates. Greece remained in the spotlight as negotiations continued with its international creditors to unlock financial aid. The impasse pushed the yield on 10-year Greek government bonds to more than 11%.
Non-U.S. stocks offer pockets of opportunity for stock pickers
T. Rowe Price portfolio managers remain optimistic about the investment environment for global equities in the intermediate and longer terms. However, they anticipate that growth in developed markets will continue in a stop-and-start fashion. The difficult, long-term adjustments that are needed for many markets in Europe and Japan to become more competitive are only in their early stages. T. Rowe Price managers are confident that Europe offers long-term growth potential, but the near-term outlook for the region is concerning due to disappointing corporate earnings. Lower European stock valuations reflect these worries. In Japan, we remain encouraged by the changes taking place at the corporate level, including the newfound focus on return on equity, improvements in corporate governance, and generally improving returns for shareholders. In emerging markets, returns have become considerably more reflective of underlying fundamentals at the stock and country level, which we view as a positive development. Although some individual stocks and sectors appear to be richly priced, there are opportunities for bottom-up stock selection.
Emerging markets stocks decline as investors expect Fed tightening
Emerging markets stocks declined in March as expectations of higher U.S. interest rates ahead of the Federal Reserve's last policy meeting dimmed the appeal of riskier assets. The MSCI Emerging Markets Index dropped to a two-month low in the days preceding the Fed's policymaking committee meeting on March 17 but erased some of its declines after the Fed signaled in its post-meeting statement that it was in no rush to raise rates. Disappointing economic data and a strong U.S. dollar also contributed to losses in many emerging markets whose currencies weakened against the dollar. For example, Brazilian shares barely declined in local currency terms but fell more than 11% when converted into dollars due to the poorly performing real, which lost more than 10% in March. Seven sectors in the MSCI index fell and three rose. Materials stocks fared the worst, losing more than 5%, while health care stocks gained the most, adding nearly 2%.
|MSCI Emerging Markets (EM) Index||-1.40%||2.28%|
|MSCI EM Asia Index||0.36||5.26|
|MSCI EM Europe, Middle East, and Africa (EMEA) Index||-2.87||2.02|
|MSCI EM Latin America Index||-7.45||-9.49|
Chinese stocks soar to seven-year high; Indian stocks decline on valuation concerns
- China's A share market for domestic investors surged more than 16%, while a broader measure of Chinese stocks posted slimmer gains. China's main domestic benchmark, the Shanghai Composite Index, rose to its highest level since March 2008 at month-end as domestic investors bet that the government would implement more stimuli to boost the economy. Separately, China's premier announced a 7% economic growth target for 2015, down from last year's 7.5% goal.
- Indian stocks fell, with the local benchmark posting its biggest monthly decline since February 2013, amid concerns that the recent rally is overdone. India's central bank unexpectedly cut its main interest rate for the second time this year in early March, citing weakness in parts of the economy and inflation falling faster than expected.
- Southeast Asian stocks were mixed, with those in Indonesia and the Philippines advancing while Thai stocks declined. Thailand's central bank cut its main interest rate for the first time this year to revive its economy, which has been hit by China's slowdown and weak domestic demand. Central banks in Indonesia and the Philippines, however, kept their rates unchanged.
Brazilian stocks drop on economic woes; Mexico's central bank sees worsening growth outlook
- Brazilian stocks fell as the country endured more bad economic news. Brazil's gross domestic product (GDP) shrank 0.2% in last year's final quarter from a year earlier and grew just 0.1% in 2014 from 2013, the country's statistics agency reported. Last year's growth rate marked the lowest since President Dilma Rousseff took office in 2010 and dealt another blow to her administration, which is mired in a corruption scandal involving state oil producer Petrobras.
- Mexican stocks declined. The country's central bank left interest rates at a record low for the sixth straight meeting and cautioned that Mexico's economy remains weak and growth prospects have deteriorated. The peso sank to a record low in early March, causing the central bank to intervene to support the currency.
- Stocks in Colombia, Chile, and Peru fell as the latest indicators reflected the impact of commodity weakness on the region. Chile's GDP grew 1.9% in 2014, a five-year low; Peru's finance minister cut his 2015 GDP forecast for the second time this year; and Colombia's economy grew at a weaker-than-expected pace in last year's fourth quarter. Colombia's economy is expected to grow this year at its slowest pace since 2009.
Turkish stocks fall as data confirm weak economy; Russian stocks decline
- Turkish stocks sank more than 6%. Turkey's GDP expanded 2.6% in last year's final quarter and 2.9% in all of 2014, the state statistics agency reported. While last year's growth rate beat analysts' forecasts, it fell short of the government's target and actually shrank in U.S. dollar terms. Separately, Turkey's central bank left interest rates unchanged in early March, following rate cuts in January and February, as consumer inflation rose faster than expected.
- Russian stocks declined. Russia's central bank lowered its main interest rate on March 13, its second rate cut this year, in an attempt to stem the country's economic downturn. The central bank governor signaled that further easing was likely despite annual consumer inflation of nearly 17%.
- South African stocks retreated. The country's central bank kept its benchmark interest rate unchanged in March for the fourth straight meeting, but the bank's surprisingly hawkish statement after its decision left many to believe that it will start raising rates in the coming months.
Solid fundamentals offset near-term risks
We are optimistic about the long-term outlook for emerging markets. Rising consumption, an expanding middle class, and real wage growth are the drivers of huge economic potential in the developing world. Emerging markets are trading at a significant discount on an absolute and relative basis, making current valuations compelling for long-term investors. Most emerging markets have stronger financial positions, larger currency reserves, and more flexible foreign exchange policies than they did a decade ago. Finally, most emerging markets are still expanding faster than developed ones and offer solid growth opportunities for long-term investors. In recent years, we have noted significant dispersion in the returns of emerging markets stocks even within the same country and industry. We anticipate more divergence in the performance of countries and companies than we have seen in the past 15 years, and we believe that careful stock selection will be crucial for producing good returns over time.