T.Rowe Price favours 'small cap and emerging market stocks' in post-Covid era

The Australian investment committee of global fund manager T.Rowe Price are “neutral” on Aussie stocks, ahead of what they anticipate will be a gradual recovery out of the pandemic disruption.

The fund’s outlook comes at an interesting time for global markets, as investors weigh up a number of competing forces in the wake of a strong market rally.

In its assessment of the complex balancing act, T.Rowe Price summed up the negative aspects as follows; already-extended equity valuations, with political risk ahead of the US election and uncertainty around the extent of further US fiscal support measures.

Those headwinds are offset against the globally-held view — reinforced by central bank communications — that interest rates will remain at “ultra-low” levels for longer, along with cautious optimism about post-COVID economic growth.

Could that complexity herald the long-awaited outperformance of value stocks, relative to growth? T.Rowe Price isn’t so sure.

Value stocks “could rally off oversold levels, but any rally is unlikely to be sustained as it may require a stronger growth environment, higher rates, and durable improvement in energy prices”, the analysts said.

Small cap thesis

Instead, the best way to hitch a ride to the gradual economic recovery is via “cyclical exposure through small-cap and emerging markets equities”.

However, T.Rowe Price’s small cap investment thesis is geared towards international markets, with an overnight position in its Global Equities Small Cap fund.

The analysts are neutral on Australian stocks, where “uncertainties around earnings and elevated valuations warrant a cautious position relative to global shares”.

“At current levels, the implied earnings recovery appears optimistic,” T.Rowe Price said.

While not predicting a sharp correction is imminent, they said the local market is likely to be in for more of a “consolidation” phase in the months ahead.

Turning to the Australian economy more broadly, the analysts said that many challenges still remain as policy makers try to balance social distancing restrictions with a return to economic growth.

But if those complexities reinforce the prevailing market view of the future — lower rates for longer, with muted inflation — T.Rowe Price also predicts continued outperformance among the “high quality growth stocks” which have led the market in recent years.