T. Rowe Price Is Seeing A Glass Half-Full: Here’s Where It’s Finding Opportunities

T. Rowe Price wasn’t one of the investment houses that was doom-scrolling into this year: the firm thought the recession fears were mostly overblown and was looking forward to finding some profitable contrarian plays. And it’s not doom-scrolling now. Here’s where the Baltimore-based fund giant is seeing opportunities, and why it says there’s actually room for optimism over the longer term.

What’s T. Rowe Price’s view?

Not everyone saw the bull market coming, heading into this year. And that’s one of the things that’s made T. Rowe Price stand out. But, the firm – which is an absolute behemoth with about $1 trillion invested in stocks – has found that the rest of this year isn’t so crystal clear. In its midyear update, it even admitted to feeling “reluctantly bearish” at times. With that uncertainty in mind, it’s been warning investors to stay invested but stay diversified.

That’s smart when you consider the history: over the past 80 years, US stocks have outperformed US bonds 67% of the time, on a rolling 12‑month basis, by an average of seven percentage points.

Let’s dig a bit deeper into T. Rowe Price’s current outlook.

US stocks. The firm recently dropped its underweight position on US stocks and adopted a neutral one, with earnings delivering some pleasant surprises in recent weeks. In fact, company results have been trending in a positive direction and that’s the first time in a while. T. Rowe Price’s analysts note that growth stocks, especially tech stocks, have enjoyed better results as developments in AI have given a boost to the outlook. And there’s been surprising earnings strength in industrial firms and some cyclical ones too, likely, they say, because of accelerating demand resulting from a couple of big US government spending initiatives.

AI stocks. Like seemingly everyone right now, T. Rowe Price is excited about AI stocks. The firm sees AI continuing to drive investment in semiconductors, memory and cloud storage, and other things. And its analysts see the stronger tech companies getting stronger, with the high cost of AI programs delivering an edge to bigger players. To gain broad-based exposure to the AI theme, consider the Invesco QQQ Trust Series (QQQ; 0.2%), or to gain exposure to AI’s semiconductor and memory leaders, consider the iShares Semiconductor ETF (SOXX; 0.35%).

Small caps. This year, investors might find good things in small-cap packages: T. Rowe Price’s analysts say the big-cap benchmark S&P 500 index’s price-to-earnings ratio is closer to the top of its 10‑year range than its bottom, the reverse is true for its small-cap cousin, the S&P 600. In fact, T. Rowe Price says US small‑cap firms this year have been priced like it’s 2008. And while smaller companies have historically been more vulnerable in economic downturns, analysts say the current valuation gap may be simply too attractive to pass up, especially if the US manages to avoid a recession. To add some small-cap companies to your investment mix, you could consider the Vanguard S&P Small-Cap 600 ETF (ticker: VIOO; expense ratio: 0.1%).

Real-asset stocks. This year’s AI-fueled rally has widened the valuation gap between AI-related stocks and real-asset stocks. And, well, that’s got T. Rowe Price’s attention: the firm is always on the lookout for big valuation spreads, because those do tend to shrink over time. That’s why, right now, they like real-asset stocks, the ones left behind in this year’s rally. That includes natural resources companies, real estate investment trusts (REITs), and metals and mining firms. For metals and mining exposure, there’s the SPDR S&P Metals & Mining ETF (XME; 0.35%) or, since many of the biggest metals and mining companies – think: BHP, RIO, and Glencore – are listed outside the US, you might look into the iShares MSCI Global Select Metals & Mining Producers ETF (PICK; 0.39%).

International stocks. T. Rowe Price likes the look of Japan’s stocks, in particular. Their earnings growth estimates have been higher, and longer‑term factors are starting to tilt in their favor too, like improved corporate governance and capital allocation – that is, the pay-out ratios via dividends and share buybacks. Plus, their valuations are super cheap. I mean, there’s even the potential for Japanese pension funds to reverse their 25‑year habit of being sellers of Japanese equities – and instead actually buy them. The iShares MSCI Japan ETF (EWJ; 0.5%) provides broad exposure to Japanese stocks, without a currency hedge.

T. Rowe Price has recently become more concerned about the outlook for European stocks, despite some recent earnings growth that rivaled that of the S&P 500. A 15% oil price rally in July and the bloc’s scorchingly hot summer will lead to a costly increase in energy needs, undermining the more positive economic outlook. And it’s taking a cautious approach to China’s stocks, after some disappointing economic data there.

What are the risks?

In the US, a strong job market and some robust pandemic-era savings have supported consumer demand – and that’s good from an earnings standpoint, but maybe not-so-good for the inflation and interest rate outlook. As T. Rowe Price notes, the big worry is if inflation gets stuck for a while in its recent 3% to 4% range, which is still well above the Federal Reserve’s (the Fed’s) 2% target. The Fed’s already unleashed some huge interest rate increases, bringing its key rates to 5.25% and 5.5%, and the impact of those hasn’t fully worked its way through the economy. In other words, there could be a fair amount of economic pain ahead.

And that’s a risk that’s on just about everyone’s radar, but here’s one that’s not: T. Rowe Price is watching for a potential change in monetary policy from the Bank of Japan (BoJ) that could rattle markets everywhere. In the words of T. Rowe Price’s head of international fixed income: “Japanese monetary policy could be the San Andreas Fault of global finance.” Last week, the BoJ said it would hold steady on its limits around the 10-year bond yield, but said it would consider those edges "references" rather than "rigid limits". And it said it would offer to buy 10-year Japanese government bonds at 1% in fixed-rate operations, rather than the previous 0.5%, suggesting it would tolerate a rise in the 10-year yield to as high as 1%. So far, the yield has notched only slightly higher, to 0.57%. But if it continues to rise, Japanese investors might decide to start bringing their wealth back home – delivering a huge shock to markets outside Japan.

And that’s something to watch out for.