August 2015

China worries spark market correction
U.S. stocks fell sharply in August as worries about a Chinese economic slowdown sparked global market volatility. The large-cap S&P 500 Index endured its sharpest monthly decline in over three years, while the narrowly focused Dow Jones Industrial Average fell the most since May 2010, the month of the so-called flash crash. All of the major benchmarks entered correction territory—commonly defined as a drop of at least 10% from the recent peak—and the Nasdaq Composite was the only one that managed to end August with a gain for the year-to-date period. Within the S&P 500, the telecommunication services and utilities sectors held up best, while health care, financials, and consumer discretionary shares declined the most. Despite the plunge in oil prices during the month, the energy sector held up better than the broader market thanks to a month-end rally in both the price of oil and energy shares.

U.S. Stocks
  Total Returns
MSCI Indexes August 2015 Year-to-Date
Dow Jones Industrial Average    -6.20%     -5.68%
S&P 500 Index -6.03  -2.88
Nasdaq Composite Index -6.86   0.85
S&P MidCap 400 Index -5.58  -1.48
Russell 2000 Index -6.28  -2.97
Note: Returns are for the periods ended August 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.

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.

China lets yuan fall, sparking devaluations in other emerging markets currencies
Signs of a steeper-than-expected slowdown in the Chinese economy appeared to be the primary culprit in U.S. stocks following global markets lower. At the start of the month, reports of a plunge in Chinese exports and a decline in manufacturing activity sparked a global sell-off, and the declines accelerated after China announced that it would permit the yuan to fall against the U.S. dollar. The Chinese government's decision to devalue the currency, will—all things being equal-make its goods cheaper in overseas markets and raised further concerns about the extent of China's economic slowdown. The move also led to fears of competitive devaluations by China's neighbors and trade partners, and several other emerging markets currencies soon fell sharply. The Chinese government's efforts to bolster stock prices and provide liquidity to the banking system briefly boosted global markets, but their mixed results also raised fears about the ability of its leaders to guide the country's economy.

Drop in commodity prices may be more durable and profound
The month's other major global financial disruption came from the ongoing drop in oil prices, which reached six-year lows before a sharp bounce at the end of the month. The drop appeared to be partly in response to the slowdown in Chinese demand, but supply concerns also took a toll. Stockpiles of U.S. crude continued to rise, leading to some concerns that major storage facilities would soon run out of room. Meanwhile, Saudi Arabian production topped the peak it had established in 1980, and traders braced themselves for the arrival of significant new supplies from Iran once sanctions are lifted. Prices for other commodities, including copper, followed oil lower and weighed heavily on materials stocks. T. Rowe Price analysts and portfolio managers believe that the global economy has entered a long-term cycle of declining commodity prices that will be exacerbated by declining production costs.

Upside of falling commodity prices seen in data but fails to reverse sentiment
The upside of lower energy and commodity prices for consumers was also evident in August, although it appeared to provide little comfort to investors. Economists have been looking for lower gasoline prices to stimulate spending, and several prominent retailers reported better-than-expected earnings. The trend was particularly pronounced among building supply stores, which are also benefiting from continued strengthening in the housing sector. Reports showed July sales of both new and existing homes reaching their fastest pace in eight years. T. Rowe Price Chief U.S. Economist Alan Levenson thinks that the improving job market and demographic trends are resulting in a higher rate of household formation, which should continue to provide support for the housing market.

Speculation about the timing of first Fed rate hike adds to volatility
Questions about how policymakers will weigh global financial disruptions against the continuing U.S. economic recovery raised doubts about the timing of the Federal Reserve's first rate hike and likely exacerbated August's market volatility. Many investors had expected the Fed to raise rates at its mid-September meeting, but markets rallied late in August after a Fed official suggested that the central bank might wait until global financial conditions had stabilized. Markets then headed lower on the final day of the month, however, after another official indicated that a September rate hike was still possible.

Innovative, consumer-oriented firms likely to feel less impact from China
While the scale of the recent volatility has been extraordinary, T. Rowe Price's U.S. equity portfolio managers were not surprised to see a market pullback following several years of significant gains that had pushed stock valuations to above-average levels. Nonetheless, they are keeping a close eye on developments in China, which has accounted for a large proportion of recent growth in both the global economy and the profits of some multinational firms. While U.S. energy and infrastructure-related firms have already been heavily affected, the firm's portfolio managers and analysts note that multinationals serving Chinese consumers have held up relatively well. The firm's growth-oriented managers also observe that innovative U.S. technology and health care firms—the largest sectors for large-cap growth investors—are more domestically oriented and have little or no direct business in China, leaving them with less exposure to a slowdown in its economy.

August 2015

China's currency devaluation triggers dramatic volatility
The yield on the 10-year U.S. Treasury note finished August at 2.21%, nearly unchanged from where it started. However, Treasury yield levels at the beginning and end of August masked dramatic volatility within the month. On August 11, China expanded the trading range for the yuan to let the currency devalue, triggering fears that the Chinese government is struggling to manage a deceleration in the country's economic growth. Coupled with wild swings in the Chinese stock market, the devaluation caused selling pressure on riskier asset classes worldwide, particularly in emerging markets securities and currencies. During the worst of the selling in equities, Treasuries enjoyed strong demand from safe-haven investors that pushed the 10-year Treasury note's yield down to almost 1.90%. (Bond prices and yields move in opposite directions).

U.S. economic data continue to improve
While investors worried about growth in emerging markets, U.S. economic data continued to show improvement. The unemployment rate remained at a seven-year low of 5.3% in July, and the Commerce Department revised its estimate of second-quarter gross domestic product growth up to 3.7% from an initial 2.3%. However, the sudden increase in financial market volatility during the month convinced some investors that the Federal Reserve will not raise rates in September. In a late-month speech, Federal Reserve Bank of New York President William Dudley said that recent market volatility and concerns about foreign economies have made the case for a September interest rate increase "less compelling." That statement helped boost sentiment for riskier assets. T. Rowe Price Chief U.S. Economist Alan Levenson continues to believe that the Fed will actively consider a rate hike at its September policy meeting.

Emerging markets debt drops steeply
With the turmoil focused on developing countries, emerging markets bonds declined considerably in August. Emerging markets debt denominated in U.S. dollars held up much better than locally denominated bonds, which lost more than 5% as the devaluation of the Chinese yuan dragged many other emerging markets currencies lower against the dollar. Unstable oil prices weighed on bonds issued by oil exporters Brazil, Russia, and Colombia. Concerns about Brazil's ability to maintain its investment-grade status rose as the country struggled with stalled reforms and an expanding corruption investigation. Government bonds from developed non-U.S. countries advanced slightly in U.S. dollar terms.

Total Returns
Index August 2015 Year-to-Date
Barclays U.S. Aggregate Bond Index    -0.14%     0.45%
Credit Suisse High Yield Index -2.05  0.09
Barclays Municipal Bond Index 0.20 1.04
Barclays Global Aggregate Ex-U.S. Dollar Bond Index 0.35 -5.22
J.P. Morgan Emerging Markets Bond Index Global Diversified -0.91 1.24
Barclays U.S. Mortgage Backed Securities Index 0.08 1.02
Figures as of August 31, 2015. Past performance cannot guarantee future results. This chart is shown for illustrative purposes only and does not represent the performance of any specific security.

Risk aversion and oil price volatility weigh on high yield bonds
High yield bonds also suffered amid the increased risk aversion and as oil prices fell for most of the month. Bonds from energy-related companies account for a substantial proportion of high yield benchmark indexes. Yields on bonds in the energy and metals and mining sectors surged well into distressed territory, pushing yields in other high yield sectors higher as well. Oil prices rose sharply at the end of August, which helped moderate some of the losses in the high yield market.

Credit spreads widen on investment-grade corporate bonds
Investment-grade corporate debt held up better than the high yield bond market but still posted declines as investors shied away from risk. Credit spreads increased to their highest level in three years, with bonds issued by companies in the energy sector experiencing the most dramatic widening. (Credit spreads measure the additional yield above that of a comparable-maturity Treasury security that investors demand for holding a bond with credit risk.) Issuance of investment-grade corporates stalled amid the elevated volatility, and the limited new supply provided some support for the market. Investors expect a rush of new deals after Labor Day.

MBS and ABS benefit from insulation from international worries
The slightly positive returns of securitized debt, including mortgage-backed securities (MBS) and asset-backed securities (ABS), made the segment one of the strongest performers in fixed income. MBS and ABS both benefited from their relative insulation from the turbulence in international financial markets and the steep decline in energy prices that dominated the month. Credit spreads on most segments of the MBS and ABS markets tightened, bucking the overall fixed income trend.

Treasury Yields
Maturity July 31, 2015 August 31, 2015
3-Month    0.08%   0.08%
6-Month   0.14   0.27 
2-Year   0.67   0.74 
5-Year   1.54   1.54 
10-Year   2.20   2.21 
30-Year   2.92   2.95 
Source: Federal Reserve Board

Positive returns for municipal debt
Municipal bonds generated positive returns as a result of support from significant reinvestment of coupon payments as well as their lack of exposure to international woes and volatile commodity prices. As expected, Puerto Rico missed most of a $58 million bond payment at the beginning of the month. The default was widely telegraphed and had little effect on the municipal market as the U.S. territory's financial troubles are widely known. Detroit sold new municipal debt for the first time since exiting bankruptcy protection, issuing $245 million of bonds backed by income tax revenue. The city offered the new bonds at an attractive yield premium relative to similarly rated municipal debt.

Volatility can create buying opportunities
Sharp increases in volatility can create price distortions—on either individual securities or entire sectors—that we strive to locate and exploit. Our multi-sector fixed income strategies have significant holdings of cash and other liquid assets that we can quickly sell and reallocate if we see opportunities elsewhere. We think that the non-agency MBS market is attractive as the housing market settles into what appears to be a healthy, sustainable recovery. In addition, we favor bank loans as a relatively defensive way to access the still-solid fundamentals of the below investment-grade market.

August 2015

Nowhere to hide in the August sell-off
Concern about the health of the Chinese economy and its impact on worldwide economic growth led to global stock market volatility and widespread losses. Developed and emerging markets equities plunged, in many cases erasing all of their year-to-date gains. Rather than a steady decline, stocks zig-zagged throughout the month, but strong rallies failed to match tumbles. However, the selling intensified in mid-August, leaving the developed market MSCI EAFE Index more than 7% lower and the MSCI Emerging Markets Index down about 9%. Developed European and Asian markets posted similar losses. In emerging markets, equities in the Europe, Middle East, and Africa region held up better than those in Latin America and Asia.

Every sector in the EAFE index declined more than 5%, with energy and materials stocks falling furthest and telecommunication services, information technology, and utilities holding up best. Small-cap stocks marginally outperformed large-caps and maintained a sizable year-to-date advantage. Growth stocks extended their 2015 outperformance versus value shares. The euro and yen were modestly stronger against the greenback, while the British pound declined.

International Indexes
  Total Returns
MSCI Indexes August 2015 Year-to-Date
EAFE (Europe, Australasia, Far East)    -7.35%      0.14%
All Country World ex-U.S. -7.63  -3.86
Europe -7.11  -0.10
Japan -5.81   7.69
All Country Asia ex-Japan -9.79 -10.75
EM (Emerging Markets) -9.01 -12.62
All data are in U.S. dollars as of August 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.

Source: 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.

China cuts rates, reduces reserve requirements, and severs the yuan's peg to the dollar
The recent abrupt swings in financial markets seem to have stemmed from worries about flagging economic growth in China and its unexpected currency devaluation. The People's Bank of China devalued the yuan by 1.9% on August 11, and at the end of the month it was 2.6% lower versus the dollar. In devaluing its currency, China is seeking to move toward a more flexible, market-oriented exchange rate with the goal of making the yuan a free-floating global reserve currency. China's industrial sector is clearly slowing, but its gradual transformation to an economy led more by services and domestic consumption and should be a longer-term positive for the country. Additionally, China's central bank cut interest rates for the fifth time since November 2014 and reduced the amount of reserves that banks must hold in order to add liquidity to the financial system.

Despite the August sell-off, Japanese stocks higher in 2015
Japanese equities held up better than most of their global developed market peers and remain solidly positive for 2015. The year-to-date outperformance reflects the Bank of Japan's stimulus initiatives, an improving corporate earnings outlook, and a weaker yen. Additional support for Japanese stocks has been provided by the massive Japanese postal savings and insurance systems and the Government Pension Investment Fund, which have shifted assets from government bonds into Japanese equities. The Bank of Japan has continued with accommodative monetary policies, including a zero interest rate and purchases of Japanese government bonds and other assets and remains committed to reaching its 2% inflation goal. However, structural reforms have been difficult to carry out, and the economy contracted 1.6% year-over-year in the second quarter. Despite stronger government spending, exports to China were below expectations, and Japanese consumers cut back on their spending.

European stocks are relatively cheap
Second-quarter European economic growth slowed modestly to a 1.3% annualized rate. While events surrounding the Greek debt crisis weighed on near-term growth, the region is supported by diminished fiscal headwinds, an improving credit environment, low energy costs, and the weaker euro. Dean Tenerelli, London-based portfolio manager of the T. Rowe Price European Stock Fund, sees eurozone growth forecasts improving across its core countries. He notes that the most recent earnings season for European companies has been the best since 2010. While he is concerned about China's economic growth because it is a significant European trading partner (especially with Germany), he believes that prices of European companies are relatively cheap and trading below their long-term historical average.

Greece receives bailout funds
The finance ministers from 19 eurozone countries agreed to the latest round of bailout funds for Greece, just in time to avoid a default on its €3.2 billion debt payment to the European Central Bank. Most of the first €26 billion ($29 billion) installment of the total three-year €86 billion ($96 billion) rescue package was paid in August. The deal represents the third bailout for Greece in five years. Shortly after the deal was inked, Prime Minster Alexis Tsipras resigned and asked for the earliest possible snap election date in an effort to consolidate power within his party.

Modest slowdown in growth overall
Global economic growth expectations have been ratcheted down modestly for 2015. Japan's growth has faltered, and emerging markets expansion has been hurt by the weakness in the heavyweights China, Russia, and Brazil. The key risks for global markets include the impact of global monetary policy actions, increased currency volatility, and the political and policy uncertainties facing key emerging markets that are already dealing with weaker growth. While the many non-U.S. economies are in earlier stages of recovery than the U.S., non-U.S. economies and companies are expected to benefit from their relatively weaker currencies and support from aggressive monetary policies.

Allocation team favors overweighting non-U.S. and emerging markets equities
The T. Rowe Price Asset Allocation Committee is overweighting non-U.S. equities versus U.S. equities, based on the prospects for stronger earnings growth and modestly more attractive valuations outside the U.S., although valuation disparities exist across regions and sectors. Overall, earnings and margin levels in non-U.S. markets are well below pre-crisis levels compared with the U.S., where earnings and margins are at peak levels. The committee has increased its overweight to emerging markets versus developed markets as valuations have fallen further. While weakening economic growth in developing nations and rising U.S. interest rates remain near-term risks, emerging markets valuations appear to be discounting their longer-term growth potential. Although low energy and commodity prices may continue to weigh on commodity-exporting emerging markets, consumer-driven and service-oriented economies should benefit.

August 2015

Emerging markets stocks tumble on China fears; MSCI EM Index hits six-year low
Emerging markets stocks posted their biggest monthly drop in more than three years after China devalued its currency on August 11, raising fears about the health of the world's second-largest economy. China's central bank said the surprise devaluation was intended to make the yuan more market-oriented, but the move aroused suspicions that the government was trying to revive an economy that is expanding much slower than the official 7.0% growth target for this year. The devaluation also stirred doubts about the ability of China's leaders to effectively manage a slowdown after officials unsuccessfully tried to stem a stock market sell-off that had started in June. Currencies in the emerging world slumped as investors fled riskier assets. Indonesia's rupiah and Malaysia's ringgit sank to their lowest levels against the dollar since the 1997 Asian financial crisis, while the South African rand, Turkish lira, and Mexican peso touched all-time lows.

The MSCI Emerging Markets Index slid roughly 9%, its biggest monthly decline since 2012 according to Bloomberg, and ended the month at its lowest level since July 2009. Every market in the index fell except Jordan. August's slump dragged almost all emerging markets into negative territory for the year, with the exception of Russia and a few Eastern European countries. All 10 sectors in the index retreated. Financials and utilities fared the worst, with each giving up about 11%. Health care declined the least, shedding a relatively modest 3%.

International Indexes
  Total Returns
Index August 2015 Year-to-Date
MSCI Emerging Markets (EM) Index      -9.01%      -12.62%
MSCI EM Asia Index   -9.16   -11.23
MSCI EM Europe, Middle East, and Africa (EMEA) Index   -7.22     -7.91
MSCI EM Latin America Index -10.50   -23.07
All data shown are in U.S. dollars as of August 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.

Source: 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.

Chinese stocks fall after devaluation; Southeast Asian stocks drop on currency war fears

  • Chinese stocks fell nearly 12% while the restricted A shares market for mainland investors sank about 14%, pushing both gauges into the red this year. China's central bank cut its benchmark lending and deposit rates and reduced the required reserve ratio for banks on August 25—the second time in two months it simultaneously made both moves—eain an effort to support stock prices and stabilize the economy.
  • Indian stocks shed almost 9%. India's gross domestic product (GDP) expanded at a slower-than-expected 7.0% in the June quarter, down from the previous quarter's 7.5% pace. The disappointing growth increases political pressure on the roughly year-old government of Prime Minister Narendra Modi, who promised to overhaul the economy but has lately backtracked on some key reforms.
  • Southeast Asian stocks fell as China's yuan devaluation sparked a currency sell-off in the region, raising worries that other Asian countries would resort to depreciation to protect their exports. The risk of a currency war comes as the region is struggling with slowing growth and expected capital outflows once the U.S. starts raising interest rates. Malaysian stocks lost more than 15% as a corruption scandal involving the prime minster sapped investor confidence.

Brazilian stocks drop on poor economic news; Andean markets fall on commodity weakness

  • Brazilian stocks slumped 14% as the economic outlook remained poor. Brazil's jobless rate hit a five-year high in July and its economy shrank more than expected in the second quarter, when it officially fell into a recession. Moody's lowered its rating on Brazil's government bonds to one notch above junk but raised its outlook to stable from negative, citing the country's turnaround potential.
  • Mexican stocks slid 6.5%. Mexico's GDP expanded at a moderate 2.2% pace in the second quarter from a year earlier—in line with forecasts, but leaving the economy on track for a third straight year of disappointing growth. Mexico's central bank slashed its 2015 growth estimate to a 1.7% to 2.5% range, reflecting the impact of falling oil prices and lower production.
  • The Andean markets of Chile, Colombia, and Peru retreated as falling commodity prices and China's devaluation caused their respective currencies to plummet. A weaker yuan erodes China's purchasing power for oil, copper, and other raw materials produced in the region, whose economies have long relied on Chinese demand.

Russian, South African stocks drop as oil and commodity prices slide

  • Russian stocks fell nearly 6% due to falling oil prices and the plunging ruble, which declined for the fourth straight month. Brent crude, the benchmark for Russia's main oil export, sank to a six-year low in late August before rebounding by month-end.
  • Turkish stocks slid about 10% amid political instability after talks to form a new coalition government collapsed, forcing the interim prime minister to call new elections. Turkey's central bank left its various interest rates unchanged and unveiled a plan to simplify monetary policy by moving toward a single policy rate, but the move left markets unimpressed and the lira fell to a record low.
  • South African stocks slumped more than 7%, weighed by data showing that the country's economy unexpectedly shrank in the second quarter. The country's GDP contracted at an annualized 1.3% pace, its worst quarterly performance in a year, increasing the risk of a recession in a country already struggling with widespread power outages and slumping commodity prices.

Solid fundamentals in emerging markets 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 long-term growth opportunities. In recent years, we have noted significant dispersion in the returns of emerging markets stocks even within the same country and industry. We anticipate further divergence in the performance of countries and companies, and we believe that careful stock selection will be crucial for producing good returns over time.