January 2015

Falling oil prices and the rising U.S. dollar prove a harmful mix for stocks
Stocks started out 2015 on a down note, as plunging oil prices and a rising U.S. dollar dampened the earnings and outlooks for many firms. The weakness in several heavily represented bank, energy, and industrial holdings took a larger toll on the Dow Jones Industrial Average and Standard & Poor's 500 Index than it did on the Nasdaq Composite. The small-cap Russell 2000 Index performed in line with the large-cap benchmarks, but the S&P MidCap 400 Index fared somewhat better. Financial stocks performed worst among S&P 500 sectors, followed by energy shares, while the typically defensive utilities and health care sectors were the only two segments to record a gain for the month.

U.S. Stocks
  Total Return
MSCI Indexes January 2015 Year-to-Date
DJIA    -3.58%      -3.58%
S&P 500 Index -3.00   -3.00
Nasdaq Composite -2.13   -2.13
S&P MidCap 400 Index -1.12   -1.12
Russell 2000 Index -3.22   -3.22
Note: Returns are for the periods ended January 31, 2015. The returns include dividends based on data compiled by T. Rowe Price, except for the Nasdaq Composite Index, whose return is principal only.

Past performance cannot guarantee future results. This chart is shown for illustrative purposes only and does not represent the performance of any specific security.

Plunging oil prices have broad impact
Stocks fell sharply early in the month as the price of crude oil reached multiyear lows, with a barrel of West Texas Intermediate down nearly 60% from its mid-2014 peak. Although the decline in gasoline prices provides a welcome boost to consumer spending, lower oil and gas revenues weighed heavily on energy stocks. Energy firms have also been an important source of new hiring in recent years, and reduced exploration and production in the nation's new shale reserves may slow jobs growth. In addition, reduced capital expenditures by energy companies threaten the earnings of linked industrial firms, such as barge and rail operators. T. Rowe Price managers and analysts note that wide price swings in any key commodity or financial instrument—even if ultimately beneficial—can have disruptive effects on markets, as we have recently witnessed in the decline of the Russian ruble and the currencies of other oil-producing nations.

Strong dollar also weighs on stocks
Investors also kept a close eye on the strength of the U.S. dollar, which has appreciated substantially due to more rapid growth in the U.S. economy relative to many overseas countries. A stronger U.S. dollar threatens to weigh on the earnings of U.S. multinationals, as it reduces the dollar value of profits earned in weakening foreign currencies and makes goods produced in the U.S. more expensive overseas. Industrial stocks tied to the global economic cycle proved particularly poor performers late in the month. T. Rowe Price industrial analysts and managers expect revenues in the sector to face continued pressure in the coming months, but they believe that lower prices for oil and other commodities will eventually boost consumer spending and provide a tailwind for industrial stocks.

S&P 500 earnings likely to fall for first time in two years...
The market's decline reflected the combined negative impact of falling oil and the rising dollar in earnings reports and profit outlooks. By the end of the month, analytics and data firm FactSet was estimating that profits would grow by only 2.1% in the final quarter of 2014, well short of the 8% growth predicted just a few months ago. FactSet also reported that analysts expect earnings to decline year-over-year in the first quarter of 2015, the first such reversal in two years. Aside from energy, financials earnings were also hit particularly hard late in 2014, which was reflected in their particularly poor stock performance in January.

...Even as the U.S. recovery remains on track
January's U.S. economic data were generally positive. Labor market signals remained strong, and the University of Michigan and Thomson Reuters reported that consumer sentiment had reached its highest level in 11 years, thanks in part to falling gasoline prices. The pump savings appeared to help compensate for disappointing wage gains late in 2014, and the Commerce Department reported that consumer spending had expanded at a solid annualized pace of 4.3% in the final quarter of the year. The widening trade deficit and restrained business spending caused growth in the overall economy to slow from its very strong pace in the second and third quarters, however. T. Rowe Price Chief U.S. Economist Alan Levenson expects that low gasoline costs in 2015 will further boost consumer purchasing power, and residential construction may pick up a bit. He cautions that business capital spending carried little momentum into the new year, however, with the mining and exploration segments particularly weak.

Higher volatility but lower correlations may reward careful investors
T. Rowe Price managers note that rapid changes in commodity prices and currencies often create dislocations that ripple through global markets, such as occurred in 1997's Asian currency crisis. In addition, the full effects of such events can take years to unwind, as was the case with the oil price declines in the 1980s, which caused a slump in Texas property prices and eventually played a role in the broader savings and loan crisis. For these and other reasons, they caution that the volatility seen in the past few months may continue. On the positive side, correlations—or the tendency of stocks to move in sync with each other—have recently fallen to more historically normal levels. Generally high correlations since the financial crisis made finding market-beating stocks more challenging, since stocks often moved in response to geopolitical events or macroeconomic trends that were nearly impossible to predict. They are hopeful that the drop in correlations signals a return to a market in which stocks trade on their fundamentals and that rewards investors who research and select stocks based on their unique attributes.

January 2015

U.S. Treasuries rally, driving long bond yield to record lows
Intermediate- and long-term U.S. Treasury debt rallied strongly, driving the yield on the 30-year Treasury "long bond" to record lows. The benchmark 10-year Treasury note's yield decreased by 49 basis points (a basis point is 0.01 percentage points) over the course of the month to finish at 1.68%, its lowest level since May 2013. Investors' dovish interpretation of the Federal Reserve's post-policy meeting statement about remaining "patient" in raising interest rates helped support Treasuries. T. Rowe Price Chief U.S. Economist Alan Levenson continues to expect a mid-year initial rate hike from the Fed as labor market improvement offsets low inflation levels. The unemployment rate fell to 5.6% in December from November's 5.8% level, although most of the decline resulted from a lower labor force participation rate.

The ECB announces that it will buy sovereign debt
The extremely low yields on other high-quality government bonds also helped support U.S. Treasuries by making their yields attractive in comparison. For example, 10-year German sovereign debt yielded only 0.30% at the end of the month after the long-awaited announcement from the European Central Bank (ECB) that it will expand its asset purchases in March to include sovereign bonds. The ECB said that it will buy €60 billion (about $67 billion) per month of bonds through at least September 2016 to inject a larger-than-expected total of more than €1 trillion into the eurozone economy. Although higher-quality eurozone sovereign bonds posted strong returns in local currency terms, the U.S. dollar's ongoing move higher against the euro dragged down results in dollar terms.

Switzerland's central bank surprises by removing the franc's cap against the euro
A surprise mid-month foreign exchange policy change from the central bank of Switzerland roiled currency markets and added to the demand for safe-haven assets, including U.S. Treasuries and high-quality eurozone sovereign bonds. The Swiss National Bank abandoned a cap on the price of the franc in terms of euros that it had maintained by selling francs, triggering a sudden appreciation of almost 30% of the franc against the euro. With the ECB preparing to implement its sovereign bond purchase program, likely further weakening the euro, the Swiss central bank may have calculated that it would become increasingly difficult to maintain the cap.

Total Returns
Index January 2015 Year-to-Date
Barclays U.S. Aggregate Bond Index    2.10%     2.10%
Credit Suisse High Yield Index 0.44  0.44
Barclays Municipal Bond Index 1.77  1.77
Barclays Global Aggregate Ex-U.S. Dollar Bond Index -1.84 -1.84
J.P. Morgan Emerging Markets Bond Index Global Diversified 0.93  0.93
Barclays U.S. Mortgage Backed Securities Index 0.85  0.85
Figures as of 01/31/15. Past performance cannot guarantee future results. This chart is shown for illustrative purposes only and does not represent the performance of any specific security.

Solid investor demand for newly issued investment-grade corporate debt
Investment-grade corporate bonds generated solid returns, partially as a result of trading in rough parallel with the rallying U.S. Treasury market. Investors generally preferred newly issued investment-grade corporate debt over bonds trading in the secondary market. Expectations are for heavy sales of new bonds throughout 2015. A Canadian pipeline company brought new debt to market at the beginning of January, becoming the first energy-related issuer to sell bonds since the decline in oil prices accelerated following the late-November meeting of the Organization of the Petroleum Exporting Countries (OPEC).

High yield bonds post a positive return
Unlike the last couple of months of 2014, when plummeting oil prices dragged down the high yield bond market, noninvestment-grade bonds managed to post a positive return in January. Low energy and commodities prices continued to weigh on the asset class to some degree, but a slowdown in new issuance from the rapid pace of last year provided some support for the market. Caesars Entertainment Operating Company, which has more than $18 billion in debt outstanding, filed for Chapter 11 bankruptcy protection. The default represents the fourth-largest failure in the history of the high yield market but was not unexpected.

Another monthly gain for municipal bonds; MBS lag Treasuries
Municipal bonds extended their steady stretch of monthly gains from 2014, benefiting from the gains in U.S. Treasuries. Higher-yielding municipal debt, such as tobacco bonds, enjoyed solid demand. Mortgage-backed securities (MBS) also posted positive returns, although they significantly lagged the rally in Treasuries. Speculation that lower mortgage rates and recent policymaker moves to expand residential mortgage lending may lead to a jump in refinancing weighed on the MBS market.

Treasury Yields
Maturity December 31, 2014 January 31, 2015
3-Month    0.04%   0.02%
6-Month   0.12   0.07 
2-Year   0.67   0.47 
5-Year   1.65   1.18 
10-Year   2.17   1.68 
30-Year   2.75   2.25 

Country-specific volatility in emerging markets bonds
Credit spreads on broad indexes of emerging markets debt widened amid considerable country-specific volatility in the asset class. Credit spreads measure the additional yield above that of a comparable-maturity U.S. Treasury security (or other high-quality government security) that investors demand for holding a bond with credit risk. An increase in violence in the conflict between Russia and Ukraine triggered speculation about heightened sanctions against Russia, and Standard & Poor's cut its credit rating on the country's sovereign debt to below investment grade. Ukrainian debt continued to struggle, although some concerns have eased amid speculation that the country will be able to extend its bond maturities. Brazilian bonds were volatile as the country raised its benchmark lending rate by 0.50 percentage points to 12.25% in an effort to contain above-target inflation.

Selective relative value opportunities in high yield and emerging markets corporate bonds
We are finding some opportunities to buy high yield bonds—mostly outside energy-related industries—that have sold off to prices that don't appear to accurately reflect their fundamental values. Also, we have been selectively buying bank loans and European high yield bonds, which broadly have less exposure to commodities prices. Emerging markets corporate bonds currently offer more attractive value than U.S. corporates with similar credit ratings, but we are particularly mindful of the generally lower liquidity in emerging markets corporate debt.

January 2015

Asia's markets outperform in a volatile month for stocks, bonds, and currencies
Developed non-U.S. stock markets gained 0.50% for the month in U.S. dollar terms, according to the MSCI EAFE Index benchmark (the local currency return for the index was 3.01%). Developed markets in Asia generated better performance than those in Europe, in part due to ongoing currency weakness versus the U.S. dollar. The appreciating U.S. dollar detracts from returns for dollar-based investors holding securities in non-U.S. markets. Emerging markets stocks performed in line with developed markets, but the disparity across regions was significant. Asian emerging markets posted solid gains; the Europe, Middle East, and Africa region was about flat; and Latin American stocks endured steep losses.

Within the EAFE index, growth stocks outperformed value stocks (which posted modest losses). Small-caps trailed large-caps. Sector performance in the EAFE index was mixed. The consumer staples, health care, and telecom services sectors gained, while energy, financials, and materials recorded losses.

International Indexes
  Total Returns
MSCI Indexes January 2015 Year-to-Date
EAFE (Europe, Australasia, Far East)     0.50%      0.50%
All Country World ex-U.S. -0.13  -0.13
Europe   0.01   0.01
Japan  2.34  2.34
All Country Asia ex-Japan  2.51  2.51
EM (Emerging Markets)  0.61  0.61
All data are in U.S. dollars as of January 31, 2015. Past performance cannot guarantee future results. This table is shown for illustrative purposes only and does not represent the performance of any specific security.

Asia's stock markets hold up best
Japan's Prime Minister Shinzo Abe continued to press corporations to raise wages to increase consumption levels and reverse a 20-year cycle of wage and price deflation. Indications of durable economic improvements in Japan, together with corporate tax incentives, are expected to improve wage growth. At a year-end conference in December, Abe said that he favored a lower corporate tax rate, which would provide companies more room to offer higher salaries. The ruling coalition has agreed to cut the tax rate from 34.6% to 32.1% in the fiscal year beginning in April 2015 and to 31.3% in fiscal 2016. The Japanese economy is forecast to contract for the first time in five years in fiscal 2014. Economic growth is projected to rebound to about 2.1% in fiscal 2015, which indicates that inflation will be approximately 1%, well below the Bank of Japan's official 2% target. Since taking office in 2012, Abe has promoted economic policies that focus on aggressive monetary easing and public spending in an effort to boost the profitability of export-oriented manufacturers. However, the Japanese economy has contracted for two consecutive quarters following the implementation of a consumption tax hike to 8% in April.

The Japanese yen bucked the rising U.S. dollar trend in January and gained 2.1%, which benefited the returns on Japanese stocks for dollar-based investors. The falling value of the yen (down more than 12% versus the U.S. dollar in the past six months) helps domestic manufacturers by lowering their export costs to the U.S. and raising the purchase price for imported goods. However, a weaker yen can also fuel deflationary forces that crimp profit margins and domestic demand—as consumers delay purchases in anticipation of lower prices in the future.

The ECB comes through with QE, but returns for dollar-based investors suffer
Facing moribund economic growth and meager headline inflation, the European Central Bank (ECB) finally announced a full-blown quantitative easing (QE) program at its January 22, 2015, monetary policy meeting. Beginning in March, the central bank will expand its asset purchases to include bonds of eurozone governments, agencies, and European institutions. The total size of the new QE program, €1.1 trillion ($1.2 trillion), was much more aggressive than most had anticipated. The ECB will buy €60 billion (about $67 billion) of bonds per month through at least September 2016. Although T. Rowe Price sovereign analysts believe that the program alone will not solve the eurozone's entrenched problems, they believe the stage is set for the 19-nation bloc to defy the gloomy consensus forecasts and improve in the second half of 2015. T. Rowe Price portfolio managers say the ECB's action could encourage investors to invest in riskier assets. This also should be supportive of corporate investment as companies take advantage of low interest rates to sell bonds. The weaker euro should also help to boost exports. The euro fell nearly 7% in January versus the U.S. dollar and more than 16% in the past 12 months.

At mid-month, the Swiss central bank surprised markets by abandoning the three-year-old cap on the price of the Swiss franc against the euro, which roiled currency markets and caused instant appreciation in the Swiss franc. The move triggered demand for safe-haven investments, including U.S. Treasuries, and spurred demand for eurozone sovereign bonds, which were already trading at very low yields.

Non-U.S. stock valuations remain attractive, but dollar strength is worrisome
Many T. Rowe Price portfolio managers are optimistic about the environment for global equities in the intermediate and longer term, but potential near-term headwinds include the strengthening U.S. dollar and continued global economic weakness. Although some individual stocks and sectors appear to be richly priced, there are opportunities for bottom-up stock selection. Overall, European earnings growth has been disappointing. In Japan, we believe domestic consumption and wage inflation need to be the next growth engines to support a sustained recovery. In emerging markets, returns have been considerably more reflective of underlying fundamentals at the stock and country levels, which is a positive development, in our view.

January 2015

Emerging markets stocks rise, buoyed by rate cuts, ECB stimulus
Emerging markets stocks edged up in January as a slew of interest rate cuts across the developing world boosted investors' risk appetite. India, Turkey, Russia, and Peru were among the emerging markets to unexpectedly cut interest rates, while central banks in several other countries opted to leave borrowing costs unchanged as weak oil and commodities prices eased inflation pressures. News of the European Central Bank's (ECB) long-awaited large-scale quantitative easing program also buoyed emerging markets assets. The MSCI Emerging Markets Index surged to its highest level since last November on January 23, the day after the ECB unveiled its expanded asset purchase plan, though it pared some of its gains by month-end.

Economic data pointed to a deepening slowdown in many developing countries. The International Monetary Fund cut its forecast for global economic growth in 2015 partly due to weakness in emerging markets resulting from China's slowdown, a contraction in Russia, and falling commodity prices. The strong U.S. dollar contributed to declines in a few markets, notably Turkey and Russia, where shares rose in local currency terms but fell when converted into dollars. Five sectors rose and five declined in the MSCI index. Health care stocks rose the most, up more than 5%, while utilities lost the most, shedding roughly 2%.

International Indexes
  Total Returns
Index January 2015 Year-to-Date
MSCI Emerging Markets (EM) Index     0.61%     0.61%
MSCI EM Asia Index  2.40  2.40
MSCI EM Europe, Middle East, and Africa (EMEA) Index  0.18  0.18
MSCI EM Latin America Index -6.17 -6.17
All data shown are in U.S. dollars as of January 31, 2015. This table is for illustrative purposes only and does not represent the performance of any specific security. Past performance cannot guarantee future results.

Chinese stocks advance; Indian stocks rally on rate cut

  • Chinese stocks strengthened, but the restricted A share market for domestic investors declined. China's gross domestic product (GDP) grew 7.4% in 2014, the government announced. While the results were in line with Beijing's target, they mark an end to decades of double-digit growth as China's government focuses on rebalancing the economy.
  • Indian stocks rallied almost 8%. The country's central bank cut its benchmark rate for the first time in 20 months following signs of easing inflation. Falling oil prices have helped contain inflation and lower the import bill for India and allowed its government to reduce costly fuel subsidies.
  • Philippine stocks added almost 7%. The country's GDP grew at a surprisingly strong 6.9% in the final quarter of 2014 from a year ago, capping the third straight year of growth topping 6% and making the Philippines Southeast Asia's fastest-growing economy. Returns were mixed elsewhere in the region: Thai stocks rose slightly, while Malaysian and Indonesian stocks declined. All three countries elected to keep their main interest rates unchanged as weaker oil prices reduced inflationary pressures.

Latin American stocks fall as lower commodities demand hurts outlook

  • Brazilian stocks fell as the country endured more bad economic news. Inflation spiked to its highest level in more than three years, the country posted its first budget gap in many years in 2014, and economists polled by Brazil's central bank continued to ratchet down their 2015 growth estimates. The central bank hiked its benchmark rate for the third straight meeting since President Dilma Rousseff won reelection in October, and analysts expect more rate hikes in the coming months.
  • Stocks in Mexico shed 6%. Falling oil prices are weighing on the growth outlook for Mexico, a major crude exporter, and have dampened confidence in the country's ability to lure foreign investment to its state-run energy sector, a key reform objective. Mexico's government cut its 2015 budget by nearly 3%, which analysts believe will reduce GDP growth this year.
  • Stocks in Chile, Colombia, and Peru fell as weakness in oil and other commodities began to weigh on their resource-driven economies. Colombia and Peru trimmed their economic growth forecasts for this year and next, while Colombia and Chile kept their respective benchmark interest rates unchanged.

Russian stocks decline as ruble resumes plunge; South African stocks rise on lower oil

  • Russian stocks declined. Russia's central bank unexpectedly cut interest rates by two percentage points on January 30 in an attempt to help the economy, just one month after it hiked rates to halt panic-selling of the ruble. The surprise decision—which once again sparked a currency sell-off—raised questions about the central bank's credibility and came days after ratings agency Standard & Poor's cut Russia's sovereign credit rating to junk status.
  • Turkish stocks retreated. Turkey's central bank cut its benchmark one-week repurchase rate for the first time since July, though it left the two other rates in its so-called interest rate corridor unchanged. The surprise move followed numerous comments from government officials calling for lower interest rates, reinforcing views that the central bank was succumbing to political pressure at the risk of fanning inflation, which has exceeded the bank's target for several years.
  • South African stocks advanced as signs of slowing inflation raised expectations that borrowing costs would not increase. Falling oil prices have benefited South Africa, a net oil importer. Indeed, South Africa's central bank opted to keep its key interest rate unchanged at month-end, but it reduced its full-year growth forecast to 2.2% from a prior 2.5% estimate.

Solid long-term 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. Additionally, 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.