Where We’re Headed: T. Rowe Price Looks at 2012 Investment Strategies

Today’s ‘irrational quest for safety’ should cede to attractive stock valuations in the new year

Traders on the floor of the New York Stock Exchange (Photo: AP) Traders on the floor of the New York Stock Exchange (Photo: AP)

An “irrational quest for safety” drove all kinds of nutty economic and investment behavior in 2011, said T. Rowe Price Chairman and Chief Investment Officer Brian Rogers on Tuesday at a media conference in New York. Irrational thinking explains why companies’ cash levels are so high, why this year’s investment bubble was the 10-year Treasury note, and “why people are terrified of risk and volatility,” according to Rogers.

“This year has been an exhausting one,” said the chairman of the Baltimore-based global investment management firm with $453.5 billion of assets under management, pointing to the congressional supercommittee’s failure to come to an agreement this week as well as the debt ceiling crisis last August.

But looking ahead to 2012, five T. Rowe Price experts at the conference said investors shouldn’t give up just yet, because there’s good news ahead for some U.S. and international stocks along with certain areas of the fixed-income market.

Here, then, are T. Rowe Price’s economic and investment outlooks for 2012:

Running in Place. “Company profit margins are high and rising” and “more Federal Reserve stimulus in the year to come is likely as growth lags Fed expectations,” said Chief Economist Alan Levenson. While market volatility has been giving investors a crazy ride, the U.S. economy should see a modest but sustained recovery in 2012, Levenson says. His 2012 forecast is for real GDP growth of 2%, core consumer price inflation of 1.5% to 2% and an unchanged unemployment rate of about 9% even though job growth will pick up in the second half.

Volatility vs. Valuations. “While the market doesn’t make sense now, we’re actually quite sanguine about its growth going forward,” said John Linehan, head of U.S. equities and co-portfolio manager of large-cap value strategy. “We’ve seen a lack of conviction in the marketplace with unprecedented volatility, but we’re actually not going anywhere. For 2011, we’re roughly flat.” Looking ahead, Linehan sees a “glimmer of hope” in equity valuations. If

volatility doesn’t drive the U.S. economy into another recession, he said, stock valuations will save the day because U.S. companies are sitting on piles of cash and stocks are trading at 20-year lows in terms of price to trailing earnings. “Currently,” Linehan said, “over 200 stocks in the S&P 500 are paying higher dividend yields than the 10-year Treasury.”

Held Aloft on a Treasury Bubble. “It’s been a strong year largely on the back of Treasuries,” said Fixed Income Director Michael Gitlin. “People ask me if there’s a fixed income bubble, and I say, ‘No, there’s a Treasury bubble.’” That said, other areas of the credit market are in positive territory, especially high yield, Gitlin noted, pointing to a discrepancy between spreads and default rates. “Companies are doing quite well,” he said, remarking that fundamentals remain strong in investment-grade corporate. And in high-yield credit, he added, “there’s a disconnect between what the market is pricing in versus the true risk of default.”

And Then There’s European Banks. “Although uncertainties remain, policymakers appear to have sidestepped the immediate danger, and we are cautiously optimistic they will craft a viable, long-term solution,” said Samy Muaddi, a credit analyst in global financials. To be sure, Europe’s sovereign debt troubles have weighed heavily on the region’s banking system, raising fears of a systemic financial crisis with global implications, and Muaddi noted that the muted issuance of bank debt since June has raised liquidity concerns. “However,” he added, “the European Central Bank has ample tools to provide additional liquidity, and we do not expect any solvent European bank to fail due to lack of liquidity.”

Tech Is a Bright Spot. “This is one of the best times to be a tech investor in a very long time,” said David Eiswert, portfolio manager of the T. Rowe Price Global Technology Fund (PRGTX). “We see a rich opportunity set in technology investing.” For example, the growing base of middle-class consumers in India and China is helping to drive extreme outcomes in technology. Investors should keep in mind that “it’s very important to be a stock picker” in the technology sector, Eiswert said. For example, smartphone and tablet manufacturers are seeing a boom while companies with large exposure to the shrinking government sector are at risk.

Read AdvisorOne's complete lineup of Outlook 2012 stories.

Read Best 5 Investment Picks for 2012 at AdvisorOne.com

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