Charles Shriver earned his college degree in economics and rhetoric, otherwise known as the art of persuasive speaking. You win by “lining up your facts,” says Shriver, who runs about $40 billion across several portfolios at T. Rowe Price.
The facts line up well in Shriver’s case. Both the $4 billion T. Rowe Price Balanced fund (ticker: RPBAX) and the $2 billion T. Rowe Price Personal Strategy Growth fund (TRSGX) beat their respective Morningstar-assigned benchmarks and at least 85% of peer funds over the past three years through January. The more conservative Balanced fund returned 9.4% annually in that span, while the more aggressive Personal Strategy Growth returned 11.4% a year.
Shriver, 51, has managed both funds since 2011 and also co-chairs the firm’s asset-allocation committee, whose views inform the funds’ portfolio holdings; both funds own other T. Rowe Price funds. The 14-member committee meets monthly—and off-schedule if market gyrations and economic developments demand it. Given a change in tone at the Federal Reserve, fresh evidence of slowing growth in China, and the lingering trade conflict, get-togethers have grown more frequent lately.
Shriver recently shared his economic and market outlook with Barron’s. Edited excerpts of the conversation follow.
Barron’s: When did the asset-allocation committee last meet, and what did you discuss?
Shriver: There was a mini meeting in January. Our recently increased equity exposure and the market’s fairly strong turnaround meant we saw strong returns up through our last meeting, so there was a question of whether the market had moved up too much, too fast. Stocks no longer are cheap, but nor are they expensive. The January rally moved the S&P 500 index’s price/earnings ratio up to nearly 16 times the next 12 months’ expected earnings. But contrast that to valuations 12 to 18 months ago, when markets were distinctly expensive. At the end of November 2017, the S&P 500 had a 12-month forward P/E of 18.5.
The market’s dramatic selloff last fall provided an attractive entry point to increase our allocation to equities and bring our target allocation back to neutral from underweight.
What trends are you following globally?
We’re studying global growth measures. Growth is slowing, as expected, but at what level do things begin to stabilize? There have been negative gross-domestic-product prints quarter to quarter in Italy, Germany, and Japan. Growth in China has been slowing, as well. Various monetary and regulatory measures in China should support growth but that might take time.
Globally, which asset classes offer the best expected return for the next year?
We are neutral on equities broadly speaking. We’re increasing our overweight to emerging market stocks, as valuations are reasonable and these markets should benefit from China’s stimulus measures. The forward P/E on the MSCI Emerging Markets index bottomed at 10.5 times earnings at the end of October. That is cheap; a valuation of 12.5 times would be expensive. With the U.S. Federal Reserve being more data-dependent in making interest-rate decisions, the upward pressure on interest rates has come off. Last year, interest rates were a tailwind for the dollar, and a stronger dollar was problematic for emerging market stocks.
We are also overweight emerging market debt. Many of our funds are invested in dollar-denominated emerging market bonds, but where there is ability, we invest in emerging market local-currency debt, as well.
What if China’s stimulus measures don’t work?
Manufacturers in Europe were beneficiaries of China’s stimulus measures in 2015 and saw those benefits in 2017. The nature of the current stimulus is likely to have less of an impact, because it is more oriented to domestic consumption. China is trying to lessen its dependence on fixed-asset investment and infrastructure and raise consumers’ share of economic growth. They’ve lowered reserve requirements for banks. They’ve invested in rail lines in major metropolitan areas. Last year, they lowered tax rates for lower-income cohorts. These measures generally take effect with a lag, so we should see the impact come through in the second half of this year.
Under what circumstances might you turn negative in your economic outlook?
A meaningful uptick in unemployment would be disconcerting. Capital expenditures have been at a moderate level, but if they were curtailed, that would be concerning. S&P 500 capex averaged 36% of corporate cash flow from 1998 to 2017, but was only 29% in 2017. There’s uncertainty around trade policy, and that has been weighing on capital spending. A downturn in corporate-earnings forecasts would present a challenge to markets. Consensus estimates for S&P 500 year-over-year growth in earnings per share is slightly negative for the first quarter of 2019, but rebounds to positive territory in the second quarter. If negative earnings growth were to persist into the second half or fade beyond a low-single digit decline, that would be concerning.
An escalation of negative rhetoric between the U.S. and China would be disconcerting. We haven’t resolved issues, but there’s active engagement, which is positive. Any meaningful uptick in inflation that would compel the Fed to respond would be a headwind.
Weaker-than-expected retail sales in December suggest weak consumer spending.
We’re watching it closely along with data from overseas, which have been coming in weaker. From a market perspective, there’s a greater balance between opportunities and risk this year.
Any recent change in style preference in the U.S.—say, between growth and value?
For much of 2018 we were neutral between growth and value in the U.S. Valuations on the growth side were expensive, and there was a narrow set of leaders. When the market sold off in the fourth quarter, we saw that as an opportunity to add to growth stocks, which would cover companies that are secular growers at more reasonable valuations and will earn a premium in a lower- growth environment. We don’t see a sufficiently high level of growth that would serve as a catalyst in the value sector or in the more cyclical parts of the economy.
Does the allocation committee have a current size bias?
In the U.S., we are underweight U.S. large-cap stocks relative to U.S. small-caps. Internationally, ex-the U.S., we are underweight small-caps given the late stage of the economic cycle, because their performance is reflective of local economic growth. We are overweight large-cap multinational companies because they have access to a greater breadth of end markets, including higher- growth areas such as China and other emerging markets.
How are you positioned in various sectors?
We are underweight real assets in the equity space, as we expect to see lower energy and commodity prices due to lower growth expectations and the impact of persistent production growth in shale. Nonetheless, there are opportunities to add value through active management.
Within natural resources, outside of our underweight to energy, there are some opportunities within nonwater utilities, industrial gases, and specialty chemicals. These areas offer solid businesses with good cash flow, low cyclicality, and low commodity-price sensitivity. Within utilities, there is also an opportunity to invest in companies such asNextEra Energy [NEE] and Duke Energy [DUK] that are well positioned to benefit from the shift toward renewable energy.
What other areas offer value?
Real estate investment trusts, or REITs. The decline in real estate stocks at the end of 2018 wasn’t as severe as the declines in broader equity-market indexes. REITs have benefited from recent easing in upward trends in interest rates. Hard assets and strong cash flows tend to be more highly valued by the market in difficult periods. Many listed real estate companies are better positioned to weather volatility in the economy or capital markets, as they are operating with lower leverage and more retained free cash flow than in the past. In addition, the level of new supply being built across various property types is reasonable relative to demand and generally not an area of concern.
Many of our real estate companies are trading at discounts to the private-market value of their real estate holdings. Demand for real estate has remained strong, and this could be supportive for continued mergers and acquisitions in the sector. Our largest positions are in apartment, office, and industrial real estate stocks, where our industry weightings are largely determined by our bottom-up approach to stock selection. High-quality real estate in land-constrained markets, run by strong management teams with well-capitalized balance sheets, should hold us in good stead during any market corrections.
Can you argue the case for or against high-yield bonds?
Equity-market return expectations are more measured following a strong rebound from the Dec. 24 lows. High-yield bonds offer attractive return potential with a roughly 7% yield and historically with close to half the volatility of equity markets. We expect economic growth to remain sufficiently supportive for the high-yield market, and default levels should remain near current lows. Many companies have taken advantage of the low-interest-rate environment to refinance debt at low rates and extend the maturity profile of their obligations.
What do you think of companies hoarding cash instead of spending?
We prefer companies generating consistent free cash flow to deploy cash intelligently on long-term investment and research. Amazon.com [AMZN] has excellent free cash flow, but the impact on reported earnings is delayed while the investment cycle is ongoing. Ultimately, these investments will be highly accretive to earnings.