August 28, 2012
The managers of T. Rowe Price's domestic stock funds recently shared their outlooks in shareholder reports covering the six months ended June 30, 2012. U.S. stocks managed a healthy gain in the first half of the year, but not before suffering a sharp correction in the spring brought about by renewed worries over the European debt crisis and other factors.
- Larry Puglia, manager of the Blue Chip Growth Fund, observes that "there is an unusual amount of uncertainty in the current environment. Even if the proper policy choices are pursued, it may take considerable time for meaningful improvement in budget deficits and economic growth."
- Joseph Milano, manager of the New America Growth Fund, concedes that "the investing environment is as tricky as I've ever encountered…There is increasing evidence that, while still very resilient, the U.S. consumer is beginning to spend less. Given that the consumer drives 70% of the U.S. economy, this could pose an incremental headwind to our economy later this year, while challenging the fundamentals of many consumer companies."
Nevertheless, years of market volatility and economic worries have caused many investors to shun stocks, which may mean that equities are attractively valued.
- Brian Rogers, the firm's chief investment officer and manager of the Equity Income Fund, notes that "reasonable equity valuations, strong corporate balance sheets, and cautious investor sentiment—as gauged by the preference for bonds, money market funds, and other "safe-haven" assets—provide support for stock prices."
The dividends paid by many established companies are appealing, especially in relation to very low bond yields.
- "We see many opportunities to invest in high-quality companies selling at attractive valuation levels with good dividend yields," Mr. Rogers notes. "In fact, most of our investments yield more than Treasury bonds and pay dividends that should grow over time, unlike the interest on Treasury bonds. For this reason, we feel that the dividend-paying stocks in [the Equity Income Fund] should continue to reward our shareholders over time."
Nevertheless, Tom Huber, manager of the Dividend Growth Fund, cautions that investors' hunger for yield has left some dividend-paying stocks expensive.
- "Some of the more defensive, higher-yielding sectors, including telecommunications, utilities, and real estate investment trusts, appear expensive," Mr. Huber notes. "There is no question that the desire for yield—not valuation—is driving the performance of these sectors."
Preston Athey, who has managed the Small-Cap Value Fund for over 20 years, believes that poor investor sentiment makes for good hunting grounds for value investors.
- "Frankly, I appreciate the market's obsession with short-term issues," Mr. Athey notes. "It results in a steady stream of opportunities for a value investor in companies whose stock price has fallen to reflect today's news, but investors seem oblivious to the firm's market position or long-term prospects. Yes, Europe might slip into recession; our taxes could go up in 2013; China may experience a slowdown. But look back in history: There are always macro issues overhanging the market. Today is not qualitatively different. And well-managed companies seem to deal with macro challenges and soldier on."
David Giroux, manager of the widely diversified Capital Appreciation Fund, believes that valuations are considerably more attractive in certain segments.
- "We think many companies that pay little or no dividends are attractively priced relative to history and relative to the market. Many of these stocks also return significant capital to shareholders each year through share repurchases, but they are not currently being rewarded for it by the market…Other companies that are compelling to us are those whose near-term fundamentals are not strong and earnings estimates may be too high but whose long-term fundamentals are solid and the valuations are depressed."
Greg McCrickard, manager of the Small-Cap Stock Fund, acknowledges that stocks in his asset class may be less attractively valued than large-caps.
- "The outlook for small-caps remains challenging relative to large-cap shares. Earlier in the year, small-caps approached and perhaps exceeded record-high relative valuations versus larger-cap stocks. Even though small-caps have underperformed large-caps on a trailing 12-month and year-to-date basis, valuations are still not appealing. Moreover, large-cap stocks have reported better earnings growth than small-caps for the past two years."
Thanks to cost-cutting measures and other factors, profits have generally held up well despite the slowly growing economy. Rob Bartolo, manager of the Growth Stock Fund, observes that flush corporate coffers are another hopeful sign for investors.
- "Attractive valuations, strategic acquisitions, and other shareholder-friendly maneuvers like share buybacks can serve as a positive catalyst for stocks, as companies put their balance sheets to work…If investor confidence returns, money currently sitting on the sidelines or in bonds may get reallocated back into stocks, leading to a healthy expansion of price/earnings multiples."
Because of the higher valuations/lower dividend yields of growth stocks, growth-focused fund prices could decline further in down markets than non-growth-focused funds. The value approach carries the risk that the market will not recognize a security's true worth for a long time, or that a stock judged to be undervalued may actually be appropriately priced. Small companies tend to have less experienced management, unpredictable earnings growth, and limited product lines, which can cause their share prices to fluctuate more than those of larger firms. Any foreign holdings would be subject to risks inherent in non-U.S. securities, including currency fluctuations. Unlike stocks, U.S. Treasury securities are guaranteed as to the timely payment of principal and interest.