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Thursday, Nov 29, 2012 7:00 PM UTC

T. Rowe: Low rates are market’s biggest ‘anomaly’

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Topics: From the Wires,

It’s not all about the “fiscal cliff.”

That’s a refreshing sentiment while stock markets are being held in thrall by every comment from lawmakers in Washington on the state of budget negotiations.

If no deal on the budget is reached by the end of the year, huge tax increases and spending cuts will start to take effect Jan. 1. Economists say those measures could push the U.S. back into recession. Yet Bill Stromberg, director of global equity and global equity research at Baltimore, Md.-based T. Rowe Price Group Inc., says that the “cliff” shouldn’t be investors’ main focus.

“Artificially low” interest rates are the biggest “anomaly,” in financial markets today, says Stromberg. When borrowing rates fall, bond prices rise, and that has created a surge of cash flooding into bond funds. Investors have added $224 billion to taxable-bond funds in the first 10 months of the year, while withdrawing a net $85 billion from U.S. stock funds, according to research from Morningstar.

People have been “pouring their money into bond funds,” says Stromberg. “They have to be aware that, at some point, interest rates will go up and there will be losses.”

Stromberg advises investors to build a diversified portfolio. Not only should they split their funds between stocks and bonds but, they should also consider investing in other regions outside the U.S., in particular emerging markets.

Here are some excerpts from the interview with Stromberg:

Q: How should investors think about the fiscal cliff?

A: I personally don’t think average investors should be structuring their portfolio around the idea of a short-term deadline in the market, at all. Their long-term asset allocation and choice of investments should be based on much longer-term horizons.

Q: How will any changes in the dividend tax rate impact investor behavior?

A: People will decide that they still need income. The available income choices in the fixed-income markets are less appealing because rates have come down as much as they have. Income-orientated stocks will remain a reasonable choice for their investment dollar and people are going to continue to own them. A lot of stocks are owned in tax-protected IRAs or in retirement accounts that are not taxed. So those folks will see no change.

IRAs, 401Ks, tax deferred savings plans are even more beneficial when tax rates go up. So, hopefully, you will see more people maximizing their contribution to those tax-protected vehicles than ever.

Q: What are some of the lessons that you have learned from the market this year?

A: Broad diversification across global fixed-income and stocks makes sense for just about everyone. This year U.S. stocks have done better than most, after a long period when emerging markets and international markets did better. I would bet you, that over the next five years the outcome is probably going to be different. Judging and picking when those outcomes are going to happen is a very hard game, even for a professional.

Long-term orientation to your thinking also makes sense. People who are trying to guess the short-term legislative iterations are just going to be frustrated.

An individual’s ability to handicap that is very low. So, getting a sensible long-term allocation, sticking with it and sticking to your plan, makes an enormous amount of sense.

Doing your homework makes sense. If you look at a lot of company situations where the management team and the board haven’t done a good job; where the board has been distracted; where there’s been a lot of change and turnover in the management — some of the basic signals that companies send are really worth paying attention to. Trying to find situations where companies are doing sensible things; that’s really important.

Q: What are your expectations for 2013?

A: Typically, early in new Presidential terms, administrations try to get the hard work done and take some pain to deal with the issues. So I’d expect a modestly positive but not particularly great market, I’d expect Congress to try and get its arms round taking some hard medicine for the country. That will send positive long-term signals but will keep a lid on growth in the near term.

I wouldn’t expect extraordinary return over the next year but, I think, over the next five to 10 years you could probably expect 6, 7 or 8 percent compounded annualized returns from stocks, and maybe in the order of 3 or 4 percent in a mixture of bonds. It’s slightly below long-term averages for both categories but still not really bad results. The country is working off a lot of its excesses. A lot of our peers around the globe are beginning to work off some of their excesses — even in Europe.

We feel better about emerging markets over the next three years than we have in quite some time, given that those markets have lagged and their economies have continued to grow.

More By Steve Rothwell.

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