T. Rowe Price 2019 Midyear Market Outlook: Time To Navigate Crosscurrents, Not Time To Be A Hero

BALTIMORE, June 19, 2019

NEWS
On the heels of a tough 2018 for many major financial markets, the uptick for much of the first half of 2019 has been swift and dramatic. In U.S. equities, the S&P 500 and Nasdaq indexes tested new highs after skirting with bear market territory in December 2018. International equities also got off to a generally strong start in 2019, with China leading the pack ahead of Europe, Japan, and emerging markets. In fixed income, virtually all corners of the market, from high quality to below investment grade, have been outstanding in the first half of 2019. High yield and emerging markets, particularly, bounced back strongly after a difficult 2018.

Heading into the second half of 2019, senior T. Rowe Price investment leaders remain cautiously positive in their outlooks about global economies and financial markets, but they warn that escalating trade disputes and populist politics in many regions have created notable downside risks.

Monetary expectations have shifted dramatically since the beginning of the year, with the Federal Reserve now seen as likely to cut interest rates before the end of 2019. Growth in Europe has weakened, as the region's vulnerability to trade risks and China's slowing economy have become more apparent. Unresolved Brexit issues continue to loom as a threat. Global central banks would like to normalize monetary policies and gradually raise interest rates, but they are constrained by disappointing economic data.

KEY 2019 MIDYEAR OBSERVATIONS

• The U.S. economy is in a "muddle through" mode. While it is slowing, major imbalances that would suggest a recession is imminent or even likely are not on the horizon. Employment markets are in solid shape, with unemployment at historic lows, yet there is very little inflation, wage inflation or otherwise. Economies outside of the U.S. are growing below trend. Earnings momentum has turned negative in Europe and Japan, while currencies are struggling versus the U.S. dollar.
• The economic expansion that has taken place since the end of the global financial crisis about 10 years ago has experienced periods of sluggishness, notably in 2011 and in late 2015/early 2016. Slowdowns do not necessarily mean the end of the economic cycle. Cycle ends are typically preceded by some form of misallocation of capital or "irrational exuberance" that is not evident today.
• Corporate earnings growth has stalled and is unlikely to serve as a catalyst to drive stock prices higher in the near term. Earnings should remain flat in the second and third quarters, but with some economic improvement, we could potentially see meaningful year-over-year earnings growth in the fourth quarter. This could provide the fuel needed to drive the market to new highs as we enter 2020; absent this improvement, however, expectations for market gains in 2020 would have to be tempered.
• While technological innovation continues at a torrid pace and newer companies disrupt legacy industries and firms, established companies are increasingly using their financial strength and brand positions to fight back, with some success. An example is Disney launching its own streaming video service to compete with Netflix. At the same time, investors are more aware of the risks associated with financing business plans that push profitability into the distant future. As a result, they are becoming more discerning about funding the disruptors. For example, some high-profile initial public offerings in early 2019 did not perform as many had expected they would.
• Political attitudes toward major technology platform companies are shifting due to rising concerns about market power, data privacy, and false content. Serious legislative efforts to restrict these companies has not yet taken place, but a stricter regulatory regime at some point in time is a possibility.
• International equities look relatively inexpensive, but earnings continue to languish. The trade war is having a corrosive effect on business confidence and capital spending, particularly in export-heavy economies such as Germany, Japan, Korea, and Taiwan.
• There is a wide disparity in international equities between companies whose stocks trade at very expensive valuations and companies whose stocks are extremely cheap. Aggregate measures such as price-to-earnings ratios are not especially instructive in this type of environment, where the differences in company valuations are so stark.
• Overall credit quality trends in the high yield bond market have improved substantially in the last 10 years. Increasingly, good-quality high yield companies are paying down debt rather than re-leveraging their balance sheets. Correspondingly, credit ratings have improved, and the asset class is much better capitalized today than it was before the global financial crisis. This bodes well for performance over the long term.
• The decrease in yield on the 10-year U.S. Treasury bond has created a tailwind for virtually all asset classes. In fixed income, Treasuries, investment-grade corporate bonds, and tax-exempt bonds have all done well. The high yield market has never lost money for two years in a row, and it's following the same pattern of recovery this year. The best total returns thus far have been in emerging markets, though pockets of concern persist, such as Argentina, Turkey, and Mexico.
• The inverted yield curve environment, in which yields on three-month, two-year, and five-year Treasuries are all below the fed funds rate, suggests that fixed income investors are essentially daring the Federal Reserve to cut interest rates. But policy rates are still near historically low levels, giving the Fed limited room to maneuver. Even if the Fed complies, it has to be careful not to make any cut(s) too severe; otherwise, it would spook the markets, which would conclude that economic conditions are worse than believed. Outside the U.S., the European Central Bank and Bank of Japan have even less wiggle room than the Fed, with some rates already at zero or negative.

QUOTES

Rob Sharps, Head of Investments and Group Chief Investment Officer
"We've had a long bull market and a long economic expansion. We're navigating crosscurrents right now, but I don't see any significant dislocations. While we remain constructive long term, it's also a challenging time to find good investment opportunities. Markets are near highs and risks are rising, so it's not time to be a hero. It's a good time to be diversified, invest strategically, and have your shopping list ready in case stocks pull back and go on sale."