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In Focus

Crisis or No Crisis?

Posted in Jan 2019
by David Eiswert,
Portfolio Manager, Global Focused Growth Equity Strategy at T. Rowe Price

A regime change is underway. We have seen clear shifts in economic sentiment and believe we have passed the peak of economic and accompanying earnings growth. The shift has been reflected in disappointing returns in most markets in the second half of last year.

As such, the recent volatility has not come as a surprise. Yet we should now ask how long will volatility last, how will policymakers respond and what should investors do to find alpha as well as preserve capital?

When we discuss regime change in this context, we mean we are moving from very easy credit conditions to a much more normal environment in terms of stimuli and other government actions.

There is also a sense that political events are affecting markets, particularly the trade standoff between the US and China although economic and market cycles remain the dominant driver.

The shift in regime from stimulus driven growth to one where central government and central bank support is no longer a given is unsettling for investors of all types, but the market correction and volatility should still lead to opportunities.

Additionally, our own global economic framework has not changed significantly even with more uncertain and volatile times. The standout features of the framework have been the low Dollar GDP growth, excess debt, excess oil and low inflation driven by technology and automation.

The consequences of the region shift are very broad and cut across politics and economics, they also impact corporate earnings power. These conditions are also blamed, at least partially, for the rise in populism given the that wages have been stagnant for some time.

We term this “deflationary progress” and believe that its structural foundations remain strong and should be lasting.

The likely scenario is that we will see a broad dispersion of stock returns and a need to position portfolios with this regime change in mind. Investors also need to prepare themselves for markedly different market patterns compared with previous cycles.

We still see this as a Crisis, Response, Improvement, Complacency (CRIC) cycle where we shift from Complacency and into the Crisis stage with the characteristics of the Response phase soon to become more apparent in three main areas: a domestic economic stimulus response in China; the U.S. Federal Reserve slowing the pace of interest rate rises; and some resolution of the U.S.-China trade dispute.

The right policy responses should shepherd the global economy back towards a ‘normal’ environment with the low growth, low return world reasserting itself. Our base case remains that politicians will avoid the worst scenarios of economic self-harm when rhetoric ultimately meets reality and the latter should come to define policy.

Our approach to investing therefore is governed by an awareness of volatility but is also looking for high quality stocks that will offer the best corporate fundamentals.

We believe that inflation will peak in the next six to nine months with technology, demographics and globalisation continuing to dampen price rises as they have in the last decade.

We will therefore be looking for companies that will benefit from fading growth and inflation expectations and that can adapt to change.

We have to acknowledge the re-emergence of populist policy and rhetoric, which is inherently uncertain in outcome, but is important to sentiment both at the single stock and aggregate level as we have seen with some of the skirmishes in the trade dispute.

These trends make it essential to embed our search for improving fundamental returns at the stock level, in part to defend our portfolio against economic deceleration while looking out for potential portfolio risks not anticipated within the broader market.

While economic growth is fading, this remains an environment of change, progress, and opportunity and one we can work with as stock pickers searching for fundamental improvements, wherever they may exist.

Key Risks—The following risks are materially relevant to the strategy highlighted in this material:

Transactions in securities of foreign currencies may be subject to fluctuations of exchange rates which may affect the value of an investment. The strategy is subject to the volatility inherent in equity investing, and its value may fluctuate more than a strategy investing in income-oriented securities. The portfolio may include investments in the securities of companies listed on the stock exchanges of developing countries.

Important Information

For investment professionals only. Not for further distribution. This material is being furnished for general informational purposes only. The material does not constitute or undertake to give advice of any nature, including fiduciary investment advice, and prospective investors are recommended to seek independent legal, financial and tax advice before making any investment decision. T. Rowe Price group of companies including T. Rowe Price Associates, Inc. and/or its affiliates receive revenue from T. Rowe Price investment products and services. Past performance is not a reliable indicator of future performance. The value of an investment and any income from it can go down as well as up. Investors may get back less than the amount invested.

The material does not constitute a distribution, an offer, an invitation, a personal or general recommendation or solicitation to sell or buy any securities in any jurisdiction or to conduct any particular investment activity. The material has not been reviewed by any regulatory authority in any jurisdiction.

Information and opinions presented have been obtained or derived from sources believed to be reliable and current; however, we cannot guarantee the sources’ accuracy or completeness. There is no guarantee that any forecasts made will come to pass. The views contained herein are as of the date written and are subject to change without notice; these views may differ from those of other T. Rowe Price group companies and/or associates. Under no circumstances should the material, in whole or in part, be copied or redistributed without consent from T. Rowe Price.

The material is not intended for use by persons in jurisdictions which prohibit or restrict the distribution of the material and in certain countries the material is provided upon specific request.

It is not intended for distribution to retail investors in any jurisdiction.

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