Tag Archives: attractive valuations

T.Rowe Says Invest With Caution in 2014

Invest with caution was the theme of T. Rowe Price’s annual Investment and Economic Outlook briefing in New York today.

With equity valuations at, or above, long-term averages, the mutual fund giant’s experts stressed that investors need to be careful. At 57 months, the bull market has officially hit middle age. And you can be sure the next five years aren’t going to look like the previous five, during which the S&P 500 Index rocketed 164%.

“Risk/reward is more balanced, and we should be risk aware,” said Bill Stromberg, the Baltimore firm’s head of equity. “Investors are finally rotating back to equities and may be too late.”

Stromberg said signs of speculative excess are appearing with margin debt on the New York Stock Exchange passing $400 billion, more than the peaks in 2000 and 2007. Still, U.S. stocks could move higher it they “truly regain favor with investors. Favor large-caps.”

Since the market never posted a decline of 5% this year, Stromberg said, “don’t be surprised by non-recessionary corrections.” However, be ready to buy stocks if the market falls between 10% and 20%.

While consumers and corporations have delevered their debt, reducing their financial risk, governments around the world have taken on more debt to provide stimulus. Central banks can’t continue this pace of borrowing and T.Rowe says the Federal Reserve Bank will begin tapering its quantitative easing strategy of bond purchases in the next six months. Even so, interest rates should stay low throughout 2014.

John Linehan, T. Rowe’s Head of U.S. Equity, said over the past three years the firm has been positive on U.S. stocks because of attractive valuations and strengthening corporate fundaments. But headwinds are coming in the form of more neutral valuations, tepid topline growth, historically high profit margins and expanding price-to-earnings (P/E) ratios.

Since the S&P 500’s most recent trough in October 2011, the index has soared 60%. During that time, P/E multiples on the benchmark climbed 41%, while earnings per shares grew only 13%. Linehan said multiple expansions like this tend to happen late in a stock market’s cycle.

He said stock prices are “not stretched,” and “still look attractive relative to bonds,” but they are “not attractive relative to history.”

“As a result, our green light is turning yellow,” said Linehan.

However, companies still have a lot of cash on their books. If companies use the cash for capital spending, mergers, acquisitions, dividends or share repurchases this could be a tailwind for the economy and the stock market.

Other attractive themes for the market going forward include the renaissance in U.S. manufacturing, the North American energy boom, and the improving U.S. economy.