Markets & Economy

Quarterly Market Review

Fourth Quarter 2017
T. Rowe Price

STOCKS SCORE SOLID GAINS AMID LOW VOLATILITY

Stocks recorded solid gains in the fourth quarter, pushing the major benchmarks further into record territory and marking the ninth consecutive quarterly advance for the S&P 500 Index. Volatility remained notably light, with the S&P 500 not recording a daily loss or gain of over 1% over the period and the CBOE Volatility Index, or VIX, reaching its lowest level on record since its 1993 inception. Large- and mid-caps outperformed small-caps, while growth stocks outpaced value across all market capitalizations. On a sector basis, consumer discretionary, technology, and financials stocks performed best within the S&P 500 Index, while utilities shares managed only a slight gain.

U.S. Stocks
 

 4Q 2017

 

Year-to-Date

 

Dow Jones Industrial Average

 10.96%

 

28.11%

 

S&P 500 Index

 6.64

 

21.83

 

Nasdaq Composite Index

 6.27

 

28.24

 

S&P MidCap 400 Index

 6.25

 

16.24

 

Russell 2000 Index

 3.34

 

14.65

Past performance cannot guarantee future results.

Note: Returns are for the periods ended December 31, 2017. The returns include dividends based on data compiled by T. Rowe Price, except for the Nasdaq Composite, whose return is principal only. Russell Investment Group is the source and owner of the trademarks, service marks, and copyrights related to the Russell indexes. Russell® is a registered trademark of Russell Investment Group.

SOLID EARNINGS AND ECONOMIC DATA BOOST SENTIMENT

Many observers noted that the market continued to “melt up” in the final quarter of 2017, with a general sense of confidence about earnings and economic growth driving the indexes’ slow and steady ascent. Third-quarter earnings reports appeared to drive the market’s gains early in the period, even if their overall tone was somewhat muted compared with earlier in the year. According to the research firm FactSet, earnings for the S&P 500 increased by 6.4% in the third quarter (on a year-over-year basis)—a significant slowdown from the double-digit gains in the first and second quarters but over twice the pace estimated before the start of earnings season. The hurricanes in August and September disrupted operations for many businesses, and hurricane-related losses by insurers contributed significantly but temporarily to the overall earnings slowdown, according to FactSet.

Economic signals were also encouraging. Hurricane-related disruptions led a sharp slowdown in payroll gains in September, but resilience in the labor market was confirmed later in the quarter, when October and November payroll gains came in at their best back-to-back pace in over a year. The unemployment rate also fell to 4.1% in October, below its trough during the 2001–2007 expansion and at or below what many economists define as full employment. The Institute for Supply Management reported that both the manufacturing and service sectors were expanding at the fastest pace in over a decade, while other data showed that sales of existing and new homes had also reached their best level since 2007. The numerous tailwinds helped Americans become more optimistic about their job and financial prospects than at any time since late 2000, according to the Conference Board’s gauge of consumer confidence.

MONETARY POLICY REMAINS ON TRACK

The outlook for monetary policy remained quite different compared with previous periods of economic exuberance, however. After falling earlier in 2017, the inflation rate began to pick up a bit in the quarter but remained below the Federal Reserve’s 2% annual target. While encouraged that the Fed would not be forced into hiking rates quickly, investors also appeared to welcome repeated assurances from Fed officials that low inflation did not signal any underlying weakness in the economy and would not deter them from their intended path of gradual rate hikes. Indeed, the Fed raised rates by a quarter point again in December as was widely anticipated. In addition, investors seemed to be relieved by President Trump’s selection of Fed Governor Jerome Powell to replace Janet Yellen as chair when her term ends in early 2018. A long-time ally of Yellen’s, Powell is widely considered likely to maintain her patient and gradualist approach to raising rates.

TAX REFORM DRIVES GAINS IN THE SECOND HALF OF THE QUARTER

The policy environment played an even larger role in the form of corporate tax reform, which drove much of Wall Street’s gains in the second half of the quarter. Throughout much of October and early November, investors appeared skeptical as to whether Republicans would be able to come to a consensus on how much and where to cut tax rates—and, in particular, whether they would be able to cut the corporate tax rate to their stated goal of around 20%. The hurdles appeared particularly large in the Senate, but stocks moved higher as it became clear in late November that a bill would pass through Congress’s upper chamber. Stocks recorded one of their best days for the quarter on November 30, after Senator McCain announced his support for the bill, virtually guaranteeing its Senate passage.

The reform rally continued into early December, the House and Senate made progress on a compromise bill—and as it became clear that a steep drop in the corporate rate remained a top priority. The S&P 500 reached its intraday peak in early trading on Monday, December 18, following news that GOP leaders had hammered out the final details of a bill (which cut the corporate rate to 21%) over the previous weekend. For T. Rowe Price’s perspective on the implications of tax reform, see “Financial Planning Implications of the U.S. Tax Reform Measure” and “U.S. Tax Reform: Investment Implications Are Mixed” at https://www3.troweprice.com/usis/personal-investing/planning-and-research/t-rowe-price-insights/explore-insights.html.

SHARPS: CURRENT ENVIRONMENT “ABOUT AS GOOD AS IT GETS,” BUT EARNINGS GROWTH LIKELY TO SLOW

In a recent investor roundtable hosted by Barron’s, T. Rowe Price group Chief Investment Officer Rob Sharps observed that the current environment is “about as good as it gets” for investors in financial assets, with “elevated asset prices, high expectations, and aggressive positioning for ‘risk on.’” He expects market leadership to narrow in the coming year, however, and he warned that regulatory action against Amazon.com, Alphabet (Google), Facebook, or other dominant Internet firms could cause disruption in the markets.

Important Information

This material is provided for informational purposes only and is not intended to be investment advice or a recommendation to take any particular investment action.

The views contained herein are those of the authors as of January 2018 and are subject to change without notice; these views may differ from those of other T. Rowe Price associates.

This information is not intended to reflect a current or past recommendation, investment advice of any kind, or a solicitation of an offer to buy or sell any securities or investment services. The opinions and commentary provided do not take into account the investment objectives or financial situation of any particular investor or class of investor. Investors will need to consider their own circumstances before making an investment decision.

Information contained herein is based upon sources we consider to be reliable; we do not, however, guarantee its accuracy.

Past performance cannot guarantee future results. All investments are subject to market risk, including the possible loss of principal. Stock prices can fall because of weakness in the broad market, a particular industry, or specific holdings. Fixed-income securities are subject to credit risk, liquidity risk, call risk, and interest-rate risk. As interest rates rise, bond prices generally fall. International investments can be riskier than U.S. investments due to the adverse effects of currency exchange rates, differences in market structure and liquidity, as well as specific country, regional, and economic developments. These risks are generally greater for investments in emerging markets. All charts and tables are shown for illustrative purposes only.

Overview

INTERNATIONAL EQUITIES POST ROBUST GAINS

International stock markets posted strong returns in the fourth quarter. Japan, as well as emerging markets, most notably in Asia, outperformed. Key equity market drivers included optimism about U.S. tax reform, strengthening global economic growth, buoyant manufacturing data, improved corporate earnings, and rising oil prices. Some of the major European indexes reached all-time highs during the period. Geopolitical events, including a vote for independence by Spain’s Catalan region and Brexit-related uncertainty, weighed on some sectors, albeit temporarily. Many major currencies, including the euro and the pound, strengthened against the U.S. dollar, lifting returns in dollar terms. But the Japanese yen and the Canadian dollar weakened slightly.

Within the MSCI EAFE Index, which tracks developed markets in Europe, Australasia, and the Far East, the energy, materials, real estate, consumer discretionary, information technology, consumer staples, and industrials and business services sectors outperformed the benchmark. Health care was flat and utilities lost ground. Emerging markets outperformed developed markets, and growth stocks slightly outperformed value stocks.

International Indexes
     Total Return

MSCI Index

    

4Q 2017               Year-to-Date

EAFE (Europe, Australasia, Far East)

 

4.27%                   25.62%             

All Country World ex-U.S.A.

 

5.06                      27.77               

Europe

 

2.26                      26.24               

Japan

 

8.52                      24.39                 

All Country Asia ex-Japan

 

8.27                      42.08                 

EM (Emerging Markets)

 

7.50                      37.75              

All data are in U.S. dollars as of December 31, 2017. Past performance cannot guarantee future results.
This chart is shown for illustrative purposes only and does not represent the performance of any specific security.

Note: MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indices or any securities or financial products. This report is not approved, reviewed, or produced by MSCI.

Regional Recap

EUROZONE ECONOMIC GROWTH STRENGTHENS

European markets reacted to a string of favorable economic news reports, including record-high manufacturing output, an upward revision in economic growth for the 19-country eurozone through 2019, stronger job creation, and an upswing in business investment. However, political tensions, particularly in Germany, Spain, and Italy, as well uncertainty surrounding Brexit negotiations periodically weighed on sentiment during the quarter. Italy’s government called for a national election on March 4. The outcome is uncertain, with no party polling above the 40% threshold that would declare a clear winner. Italian shares lost just over 2% in the quarter, and Spanish shares receded nearly 1.5%. German shares rose about 3%.

UK OUTLOOK SOMEWHAT UNCERTAIN, BUT SHARES OUTPERFORM

The European Commission in November sharply cut its forecast for 2017 UK growth to 1.5% and predicted a further slowdown to 1.3% in 2018 and 1.1% in 2019. T. Rowe Price traders said sentiment surrounding UK consumers is already low and retail sales have been lackluster. In November, the Bank of England (BoE) voted to raise its benchmark interest rate for the first time since 2007. However, UK inflation breached 3% for the first time since April 2012 (above the around 2% target set by the BoE). A Brexit agreement was reached between the UK and the European Union, paving the way to tackling trade negotiations. Quentin Fitzsimmons, a T. Rowe Price London-based fixed income portfolio manager, said that the agreement looks to be a reasonable outcome for the UK, though investors remain wary about future progress. Fitzsimmons believes that upcoming trade talks will likely be protracted, difficult, and complicated. The UK’s blue chip FTSE 100 Index repeatedly reached record highs during the quarter, helped in part by a stronger pound and optimism about U.S. corporate tax reform legislation. Despite the economic and political uncertainty, UK shares rose by nearly 6%, vastly outperforming the benchmark MSCI Europe Index, which returned just over 2%.

A RALLY IN JAPAN

Japanese equities strengthened, as robust demand helped to push both exports and imports higher in each month of the quarter. Japan logged its sixth straight quarter of growth and marked its longest expansion in more than 15 years. Investors reacted favorably to the reelection of Prime Minister Shinzo Abe and his plans for structural and economic reforms. The Bank of Japan (BoJ) made no changes to its monetary policy as inflation stayed well below its target. The BoJ maintained its target rates of minus 0.1% to the policy rate portion of the current account balances held by financial institutions, and around 0% for 10-year Japanese government bond yields with annual bond purchases kept at about ¥80 trillion.

EMERGING MARKETS STOCKS ADVANCE

Emerging markets stocks rose as synchronized global growth helped drive demand for higher-risk assets. Resurgent energy and metals prices, solid economic growth in China, and a corporate earnings recovery across the developing world continued to draw investor inflows. The MSCI Emerging Markets Index, which rose in each month of the quarter, outperformed the EAFE Index, driven by markets in Asia and the Europe, Middle East, and Africa region. In dollar terms, South Korea and India increased about 12% each on favorable economic and growth news. South African stocks rose more than 21%—aided by a 9% rand rally—amid hopes that Cyril Ramaphosa, the newly elected leader of the African National Congress, would eventually replace the country’s unpopular president. Greece soared over 13% following a preliminary bailout deal with its creditors. In Latin America, the smaller markets advanced, but Brazilian shares fell 2%, while Mexican stocks dropped 8% in dollar terms. China stocks matched the benchmark following strong industrial production and a pickup in domestic consumption. Russia and Turkey advanced less than 5%, underperforming the broad index.

OUTLOOK: CONTINUED MODEST GLOBAL GROWTH

The broadening global economic recovery should be supportive for risk assets in 2018, according to T. Rowe Price’s Asset Allocation Committee. However, relatively high stock valuations and low bond yields in many major markets provide little buffer against unexpected market events. Given elevated valuations, continued strong earnings growth will be required to sustain further stock market gains in the coming year. Positive factors include the potential for U.S. corporate tax cuts to generate further earnings upside and for domestic, demand-driven recoveries underway in Europe and Japan to underpin growth prospects in their respective markets. Risks to the outlook include a rise in geopolitical or trade tensions or the possibility of a central bank policy misstep. Overall, the committee is encouraged by the supportive factors underpinning the current outlook but remains mindful of the geopolitical and policy risks that could derail the current recovery.

Important Information

This material is provided for informational purposes only and is not intended to be investment advice or a recommendation to take any particular investment action.

The views contained herein are those of the authors as of January 2018 and are subject to change without notice; these views may differ from those of other T. Rowe Price associates.

This information is not intended to reflect a current or past recommendation, investment advice of any kind, or a solicitation of an offer to buy or sell any securities or investment services. The opinions and commentary provided do not take into account the investment objectives or financial situation of any particular investor or class of investor. Investors will need to consider their own circumstances before making an investment decision.

Information contained herein is based upon sources we consider to be reliable; we do not, however, guarantee its accuracy.

Past performance cannot guarantee future results. All investments are subject to market risk, including the possible loss of principal. Stock prices can fall because of weakness in the broad market, a particular industry, or specific holdings. Fixed-income securities are subject to credit risk, liquidity risk, call risk, and interest-rate risk. As interest rates rise, bond prices generally fall. International investments can be riskier than U.S. investments due to the adverse effects of currency exchange rates, differences in market structure and liquidity, as well as specific country, regional, and economic developments. These risks are generally greater for investments in emerging markets. All charts and tables are shown for illustrative purposes only.

YIELD CURVE CONTINUES TO FLATTEN AS FED RAISES RATES FOR THIRD TIME IN 2017

The Federal Reserve raised its short-term lending rate by a quarter percentage point at its December meeting, contributing to a further flattening of the Treasury yield curve during the period as yields of shorter-maturity securities increased while longer-maturity yields were flat or slightly lower. As tax reform progressed through the U.S. Congress, the prospect of faster economic growth and wider deficits pushed the yield on the benchmark 10-year Treasury note close to 2.50% in December, its highest level since March. However, increased demand helped drive the 10-year yield back down to 2.40% by quarter-end. Bond prices and yields move in opposite directions.

The yield of the two-year Treasury note increased to its highest level since 2008 during the period. Since the beginning of the quarter, the additional yield offered by the 10-year Treasury note compared with the two-year note shrank from 86 basis points to 51 basis points by the end of December, its lowest level since 2007 (100 basis points equal one percentage point). Prices of shorter-maturity Treasuries are more closely connected to the Fed’s monetary policy decisions, while longer-maturity bonds generally track longer-term growth and inflation expectations, which remained muted at the end of the year.

The Fed’s third rate hike of the year, announced at the conclusion of its mid-December meeting, raised the federal funds target rate to a range of 1.25% to 1.50%. The decision had been expected by the market, and the Fed maintained its forecast for three additional quarter-point moves in 2018. However, the Fed’s median forecast of 2018 real gross domestic product growth rose modestly to 2.5%, likely reflecting the expectation of fiscal stimulus from tax reform. President Trump’s nomination of Fed Governor Jerome Powell to replace Janet Yellen as Fed chair sparked little market activity, as Powell is widely expected to continue Yellen’s gradual approach to tightening monetary policy. U.S. economic news was positive, with the unemployment rate reaching a 17-year low in October.

Total Returns    

Index

4Q 2017

YTD

Bloomberg Barclays U.S. Aggregate Bond Index

 0.39%

 3.54%

J.P. Morgan Global High Yield Index

 0.87

 8.28

Bloomberg Barclays Municipal Bond Index

 0.75

 5.45

Bloomberg Barclays Global Aggregate Ex-U.S. Dollar Bond Index

 1.63

10.51

J.P. Morgan Emerging Markets Bond Index Global Diversified

 1.16

10.26

Bloomberg Barclays U.S. Mortgage Backed Securities Index

 0.15

 2.47

Figures as of December 31, 2017. Past performance cannot guarantee future results. This chart is shown for illustrative purposes only and does not represent the performance of any specific security.
Source for Bloomberg Barclays index data: Bloomberg Index Services ltd. Copyright© 2018, Bloomberg Index Services Ltd. Used with permission.
Source: Third-party vendor RIMES.

ECB REDUCES PACE OF BOND PURCHASES; BANK OF ENGLAND RAISES RATES

In the eurozone and the UK, central banks started to step away from extremely accommodative monetary policies. The European Central Bank (ECB) announced in October that it will extend its quantitative easing measures into 2018 at a reduced pace. ECB President Mario Draghi said that, starting in January, the central bank will reduce the pace of its bond-buying program from €60 billion a month to €30 billion until September 2018, “or beyond” if inflation has not met the central bank’s target. The Bank of England (BoE) followed in November with its first rate hike in 10 years, raising its bank rate to 0.50% from 0.25%. The BoE said it acted to contain UK inflation, which has recently been outpacing the bank’s 2% target, but indicated that further rate increases would come “at a gradual pace and to a limited extent.”

However, the Bank of Japan (BoJ) decided at its December meeting to leave its short-term interest rate at -0.1% and its 10-year Japanese government note yield target at about 0%. BoJ Governor Haruhiko Kuroda, unfazed by criticism about rising costs, strains on small regional banks, and diminishing returns from the easy-money policy, stated that the bank would not raise rates just because the economy is improving.

The yield of the 10-year UK government note decreased during the fourth quarter from 1.36% to 1.19%. The comparable German and Japanese yields were little changed and finished the period at 0.43% and 0.05%, respectively. Returns to U.S. investors in securities denominated in the euro and pound were enhanced over the three-month period by a weaker dollar.

Treasury Yields

Maturity

September 30

December 31

3-Month

1.06%

1.39%

6-Month

1.20

1.53

2-Year

1.47

1.89

5-Year

1.92

2.20

10-Year

2.33

2.40

30-Year

2.86

2.74

Source: Federal Reserve Board.

TAX REFORM FEARS GENERATE RECORD-SETTING MUNI BOND ISSUANCE

Despite a record-setting US$62.5 billion of new issuance in December, the municipal bond market was supported by solid demand and outperformed U.S. taxable investment-grade bonds for the quarter. There were concerns that the new tax law would eliminate the tax exemption on advance refunding bonds, which are issued to retire old debt, and private activity bonds, which are often used to fund projects such as hospitals and airports. Although the status of private activity bonds wasn’t changed in the final version of the bill, issuers moved many deals that had been planned for early 2018 to the end of 2017 to protect the tax exemption.

HIGH YIELD BONDS CONTINUE STRONG RUN AS FUNDAMENTALS REMAIN SOLID

The below investment-grade sector was supported by investor demand for higher yields, a strong equity market, and a backdrop of solid credit fundamentals with minimal defaults. Moreover, rising oil prices helped issuers in the high yield energy sector, and T. Rowe Price traders noted that shrinking net supply in the market, driven by bonds maturing or being redeemed in refinancing deals, was also fueling the rally. Credit spreads—the yield premiums that riskier securities provide over comparable-maturity Treasuries—continued to tighten, reaching their narrowest level since 2007. Spreads also tightened on investment-grade corporate bonds, which were supported by strong demand amid a record-setting US$1.2 trillion of new issuance in 2017.

Mortgage-backed securities (MBS) produced modest results for the quarter but outperformed Treasuries. The Fed began reducing its MBS holdings, but higher interest rates reduced mortgage prepayment risk and were a tailwind for the sector.

SOLID DEMAND PROVIDES SUPPORT FOR EMERGING MARKETS DEBT

Emerging markets bonds were supported by solid demand. Brazil’s central bank cut its short-term benchmark rate by a total of 1.25 percentage points during the quarter to a record low 7% and signaled that another smaller cut may be coming in February if inflation continues to decelerate. In China, bond yields climbed to their highest levels in three years as the government cracked down on speculative financial activities following October’s Communist Party Congress.

OUTLOOK: END OF QUANTITATIVE EASING COULD MEAN NEW ERA FOR FIXED INCOME MARKETS

In his year-end market outlook, Mark Vaselkiv, T. Rowe Price’s chief investment officer of fixed income, said he expects 2018 to mark the beginning of a new era in bond investing as central banks move ahead with the long process of withdrawing the quantitative easing measures introduced in the wake of the global financial crisis, with some monetary policymakers also set to hike interest rates. He believes a tightening move by one central bank in isolation would probably not cause too much concern, but a number of banks doing so at the same time could be disruptive. On the positive side, though, Vaselkiv expects growth to remain firm in many parts of the world, creating compelling opportunities in select bond market segments with credit risk.

GLOBAL CAPITAL MARKETS ENVIRONMENT

U.S. stocks continued rising in the fourth quarter, capping another year of strong gains for the equity market. It was the ninth consecutive positive year for the large-cap S&P 500 Index. Driving the year-end rally was the development of tax reform legislation that was passed by Congress and signed into law by President Trump in December. Among the biggest changes in the new tax law are reductions in tax rates for corporations and closely held businesses, reductions in marginal tax rates for individuals at most income levels, and changes to the limits for various individual tax deductions. T. Rowe Price Chief U.S. Economist Alan Levenson believes that the tax cuts could add another 30 basis points (0.3 percentage points) to gross domestic product growth in 2018. Solid measures of economic growth and merger announcements—such as Disney’s acquisition of assets from 21st Century Fox and CVS Health’s purchase of health insurer Aetna—contributed to the positive sentiment. The Federal Reserve raised interest rates on December 13, but this was widely expected and did not disrupt the equity markets.

Large-cap stocks outperformed their smaller peers, a trend that prevailed throughout 2017. The S&P 500 Index returned 6.64% versus 6.25% for the S&P MidCap 400 Index and 3.34% for the small-cap Russell 2000 Index. As measured by various Russell indexes, growth stocks outperformed value stocks across all market capitalizations—not only for the quarter, but also for the full year.

In the large-cap universe, as measured by the S&P 500, all sectors produced positive returns. Consumer discretionary stocks performed best. Financials also did well amid generally rising interest rates, which can increase the profitability of bank lending, and the passage of tax reform, which could lead to stronger economic growth in 2018. Information technology shares also produced excellent returns, adding to their gains from earlier in 2017 and surpassing all other sectors for the year. Telecommunication services, real estate, and health care stocks lagged the broad market. Utilities stocks were nearly flat, as rising Treasury yields reduced the attractiveness of these higher-yielding equities.

  S&P 500 Index S&P MidCap 400 Index Russell 2000 Index
4Q 2017 6.64% 6.25% 3.34%
Year-to-Date 21.83% 16.24% 14.65%

Past performance is not a reliable indicator of future performance.
Russell Investment Group is the source and owner of the trademarks, service marks, and copyrights related to the Russell indexes. Russell® is a trademark of Russell Investment Group.
Source: Third-party vendor RIMES, as of December 31, 2017.

Domestic bonds generally produced flat to slightly positive returns. The Bloomberg Barclays U.S. Aggregate Bond Index returned 0.39%. The Treasury yield curve flattened, as short-term yields rose in anticipation of further gradual Fed rate increases, but longer-term yields rose to a lesser extent or decreased. In fact, the difference between shorter- and longer-term Treasury yields narrowed to a 10-year low. In the investment-grade universe, long-term corporate bonds and long-term Treasury bonds fared best. Mortgage- and asset-backed securities were little changed. Tax-free municipal bonds outperformed their taxable bond peers, and high yield issues marginally outperformed higher-quality securities.

  Bloomberg Barclays U.S. Aggregate Bond Index Bloomberg Barclays Municipal Bond Index JPMorgan Global High Yield Index
4Q 2017  0.39% 0.75% 0.87%
Year-to-Date 3.54% 5.45% 8.28%

Past performance is not a reliable indicator of future performance.
Source for Bloomberg Barclays index data: Bloomberg Index Services ltd. Copyright© 2018, Bloomberg Index Services Ltd. Used with permission.
Source: Third-party vendor RIMES, as of December 31, 2017.

Stocks in developed non-U.S. markets underperformed large-cap U.S. shares. The MSCI EAFE Index, which measures the performance of stocks in Europe, Australasia, and the Far East, returned 4.27%. Developed Asian markets performed very well in dollar terms, led by Singapore’s 10% gain. Japanese stocks advanced about 8.5%. The market was buoyed by Prime Minister Shinzo Abe’s reelection, which should support his efforts to continue pursuing economic and structural reforms, and news that the economic expansion has lasted for seven consecutive quarters—a streak not seen in Japan for more than 15 years.

Eurozone markets lagged with milder gains. Although eurozone economies continued to expand, investor sentiment was hurt somewhat by some disappointing corporate earnings reports. German stocks rose almost 3%, but investors were discouraged by the inability of Chancellor Angela Merkel’s political party to form a governing coalition. Political uncertainty in Spain and Italy weighed on those markets in particular. In the UK, shares climbed nearly 6% in U.S. dollar terms, thanks to a reduction of Brexit uncertainty. The UK and the European Union reached an agreement on a so-called divorce bill, which enables the parties to proceed with trade negotiations.

Emerging markets stocks outperformed shares in developed markets. The MSCI Emerging Markets Index returned 7.50%. In dollar terms, most Asian markets performed well, led by India, South Korea, and Thailand. In Emerging Europe, Poland, Hungary, and the Czech Republic rose roughly between 6% and 8%, but regional heavyweights Russia and Turkey advanced less than 5%. In the Middle East, most Gulf Cooperation Council markets sagged, but Qatari shares rose almost 4%, helped by brisk gains in December amid hopes that the embargo against Qatar by several Middle Eastern countries would soon end. South African stocks soared 21% in dollar terms—helped by a 9% rand rally—amid hopes that Cyril Ramaphosa, who was elected as the leader of the African National Congress (ANC), would eventually replace South Africa’s unpopular President Jacob Zuma and initiate some much-needed economic reforms. In Latin America, the smaller markets advanced, but Brazilian shares fell 2% while Mexican stocks dropped 8% in dollar terms.

  MSCI EAFE Index MSCI Emerging Markets Index
4Q 2017 4.27% 7.50%
Year-to-Date 25.62% 37.75%

Past performance is not a reliable indicator of future performance.
Source: Third-party vendor RIMES, as of December 31, 2017.

Note: MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indices or any securities or financial products. This report is not approved, reviewed, or produced by MSCI.

Bonds in developed non-U.S. markets produced good returns in U.S. dollar terms, as yields eased in several eurozone sovereign debt markets. A 1.5% gain in the euro versus the dollar lifted returns to U.S. investors. UK government bond yields declined amid hopes that inflation is nearing a peak and that the UK’s negotiations to leave the EU will proceed more smoothly. The Bank of England raised short-term interest rates in November, which helped lift the pound sterling versus the dollar. The Japanese yen and 10-year government bond yield were little changed.

Emerging markets bond returns were mostly positive. Returns on local currency bonds in U.S. dollar terms varied widely, however, due to significant currency movements in some countries. On the plus side, several Asian currencies appreciated versus the dollar, as did the South African rand. However, the Brazilian real and the Turkish lira declined moderately, reducing local bond returns in dollar terms. Yields on long-term Mexican sovereign bonds climbed and the peso fell about 7% due to concerns that the new U.S. tax law could discourage investment in Mexico. Uncertainty about the fate of the North American Free Trade Agreement also weighed on Mexican assets, as a potential U.S. withdrawal could hurt the Mexican economy. In addition, Mexican central bank officials raised interest rates on December 14 and indicated that they may seek additional increases to contain inflation.

  Bloomberg Barclays Global Aggregate Ex-U.S. Dollar Bond Index JPMorgan Emerging Markets Bond Index Global Diversified  JPMorgan GBI-EM Global Diversified Index
4Q 2017 1.63% 1.16% 0.82%
Year-to-Date 10.51% 10.26% 15.21%

Past performance is not a reliable indicator of future performance.
Source for Bloomberg Barclays index data: Bloomberg Index Services ltd. Copyright© 2018, Bloomberg Index Services Ltd. Used with permission.
Source: Third-party vendor RIMES, as of December 31, 2017.

Important Information

This material is provided for informational purposes only and is not intended to be investment advice or a recommendation to take any particular investment action.

The views contained herein are those of the authors as of January 2018 and are subject to change without notice; these views may differ from those of other T. Rowe Price associates.

This information is not intended to reflect a current or past recommendation, investment advice of any kind, or a solicitation of an offer to buy or sell any securities or investment services. The opinions and commentary provided do not take into account the investment objectives or financial situation of any particular investor or class of investor. Investors will need to consider their own circumstances before making an investment decision.

Information contained herein is based upon sources we consider to be reliable; we do not, however, guarantee its accuracy.

Past performance cannot guarantee future results. All investments are subject to market risk, including the possible loss of principal. Stock prices can fall because of weakness in the broad market, a particular industry, or specific holdings. Fixed-income securities are subject to credit risk, liquidity risk, call risk, and interest-rate risk. As interest rates rise, bond prices generally fall. International investments can be riskier than U.S. investments due to the adverse effects of currency exchange rates, differences in market structure and liquidity, as well as specific country, regional, and economic developments. These risks are generally greater for investments in emerging markets. All charts and tables are shown for illustrative purposes only.

EMERGING MARKETS STOCKS END 2017 WITH BIGGEST RALLY SINCE 2009 AMID BUOYANT RISK APPETITE

Emerging markets stocks advanced in the final quarter of 2017 as signs of synchronized global growth drove demand for higher-risk assets. Solid growth indicators in China, rising commodity prices, improved corporate earnings in many emerging markets, and relatively cheap valuations versus developed markets stocks continued to draw investor inflows. The MSCI Emerging Markets (EM) Index rose each month in the quarter and ended the year with its best performance since 2009. The fourth quarter’s gains came even as the U.S. Federal Reserve raised short-term interest rates in December for the third time this year and signaled three more increases in 2018. However, subdued inflation in many emerging markets allowed their central banks to either cut or maintain interest rates during the quarter. All 11 sectors in the MSCI EM Index rose. Health care stocks gained the most, while utilities added the least.

International Indexes
    Total Returns

MSCI Index

    

4Q 2017          YTD       

Emerging Markets (EM)

 

 7.50%           37.75%       

EM Asia

 

 8.41              43.26

EM Europe, Middle East, and Africa (EMEA)

 

11.82             25.22

EM Latin America

 

-2.24             24.15

All data are in U.S. dollars as of December 31, 2017. Past performance cannot guarantee future results.
This table is shown for illustrative purposes only and does not represent the performance of any specific security.

Note: MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indices or any securities or financial products. This report is not approved, reviewed, or produced by MSCI.

CHINESE STOCKS GAIN AS GROWTH DATA REASSURE; SOUTHEAST ASIAN STOCKS RISE ON EXPORT DEMAND

  • Chinese stocks rose, though U.S. dollar-denominated shares outperformed yuan-denominated A shares. China’s economy grew 6.8% in the third quarter from a year earlier, virtually assuring that it will meet its annual growth target of about 6.5%, though most economists see a slowdown in 2018 after leaders pledged to step up measures to reduce financials sector risk at the country’s 19th Communist Party Congress in October.
  • Indian stocks surged more than 11%. India’s benchmark stock indexes rose to record levels in December as strong earnings in the latest quarter led some investors to bet on continued growth in company profits and the economy. The Reserve Bank of India left its key interest rate unchanged but raised its inflation forecast for the second half of the current fiscal year due to inflation pressures.
  • Southeast Asian stocks posted solid gains as rising global trade lifted their export-driven economies. Malaysia, Thailand, and the Philippines each reported stronger-than-expected economic growth in the latest quarter, and central banks in the region left their benchmark rates unchanged. Indonesia’s third-quarter growth missed forecasts, but the country received its second sovereign credit rating upgrade this year from Fitch, which raised the country’s credit rating to the second-lowest investment-grade rating in December.

BRAZILIAN STOCKS DECLINE ON POLITICAL UNCERTAINTY; MEXICAN STOCKS RETREAT ON PESO WEAKNESS

  • Brazilian stocks declined as the country slowly emerged from its worst recession on record and investors grew uneasy about the Brazilian president’s ability to shepherd through a pension reform bill seen as key for stabilizing the country’s finances. Brazil’s central bank cut its key interest rate by 50 basis points to a record-low 7% in December and signaled a smaller rate cut at its February meeting.
  • Mexican stocks shed roughly 8% as the peso weakened to a nearly 10-month low against the dollar near year-end. Mexico’s central bank raised its benchmark rate in December for the first time since June to a nearly nine-year high of 7.25% as inflation continued to exceed the bank’s 3% target. Minutes from Banxico’s latest meeting revealed that policymakers believed that risks to Mexico’s growth were tilted downward and that the inflation outlook had deteriorated.
  • Andean markets rose, led by Chile’s roughly 7% gain after a rally in December following the presidential election victory of pro-growth candidate Sebastian Pinera. Peruvian stocks advanced despite a political crisis surrounding the country’s president, who survived an impeachment vote in December over his role in a graft scandal involving Brazilian construction firm Odebrecht. Colombia’s central bank cut interest rates twice in the quarter as it tried to boost flagging growth. However, Colombia’s economy was dealt a setback by Standard & Poor’s, which reduced its investment-grade sovereign rating for the country by a notch in December.

SOUTH AFRICAN STOCKS RALLY ON MOODY’S DECISION, ANC ELECTION RESULTS; RUSSIAN STOCKS GAIN AS OIL RISES

  • South African stocks surged more than 21% as investors reacted with relief after Moody’s kept its investment-grade ratings on South African bonds in November and Cyril Ramaphosa was elected leader of the ruling African National Congress (ANC) party in December. The ANC results raised hopes of an early exit for scandal-plagued President Jacob Zuma and ended months of uncertainty about the country’s leadership.
  • Turkish stocks advanced as the country’s strong economic growth beat expectations. However, the lira repeatedly fell to record lows against the dollar during the quarter amid investor worries about political meddling in monetary policy as President Recep Tayyip Erdogan continued to criticize the country’s central bank for raising interest rates.
  • Russian stocks rose as Brent crude oil prices traded above $60 per barrel for most of the quarter, lifted by a November agreement struck between Russia and the world’s leading oil producers to keep limiting output until the end of 2018. Russia’s central bank subsequently delivered a bigger-than-expected interest rate cut in December, a move that the bank attributed to the agreement to extend oil output cuts since it helped tame inflation risks.

SOLID FUNDAMENTALS IN EMERGING MARKETS OFFSET NEAR-TERM RISKS

We are optimistic about the outlook for emerging markets. Most developing countries have smaller current account deficits, larger foreign exchange reserves, and more flexible currencies than they did in previous decades, reducing the risk of a financial crisis. Compared with developed markets, most emerging markets have more attractive demographics and a stronger tailwind from rising consumption. Emerging markets stocks remain attractively valued relative to developed markets stocks.

Near-term risks include a rise in U.S. protectionism and a faster-than-expected pace of rate hikes by the Federal Reserve. However, we believe that emerging markets will be able to withstand a gradual tightening of monetary policy given that their financial positions have broadly improved in recent years. Economic growth in emerging markets has stabilized, and corporate earnings are starting to turn higher after years of disappointing performance. Nevertheless, we believe that careful stock selection will be crucial for producing good long-term returns as emerging markets continue to show wide dispersion in the performance of individual countries and companies.

Important Information

This material is provided for informational purposes only and is not intended to be investment advice or a recommendation to take any particular investment action.

The views contained herein are those of the authors as of January 2018 and are subject to change without notice; these views may differ from those of other T. Rowe Price associates.

This information is not intended to reflect a current or past recommendation, investment advice of any kind, or a solicitation of an offer to buy or sell any securities or investment services. The opinions and commentary provided do not take into account the investment objectives or financial situation of any particular investor or class of investor. Investors will need to consider their own circumstances before making an investment decision.

Information contained herein is based upon sources we consider to be reliable; we do not, however, guarantee its accuracy.

Past performance cannot guarantee future results. All investments are subject to market risk, including the possible loss of principal. Stock prices can fall because of weakness in the broad market, a particular industry, or specific holdings. Fixed-income securities are subject to credit risk, liquidity risk, call risk, and interest-rate risk. As interest rates rise, bond prices generally fall. International investments can be riskier than U.S. investments due to the adverse effects of currency exchange rates, differences in market structure and liquidity, as well as specific country, regional, and economic developments. These risks are generally greater for investments in emerging markets. All charts and tables are shown for illustrative purposes only.

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