Michael Brush

Opinion: Stay defensive, with lots of cash: This mutual fund giant is cautious about markets in 2024

5 key investing insights from T. Rowe Price’s top strategists and managers

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Stay defensive, with lots of cash in your portfolio.

Every year around this time, the giant Baltimore-based investment shop T. Rowe Price Group TROW, -1.50% sends investment managers and strategists to New York City to offer a year-ahead outlook on stocks, bonds and the global economy.?

Given the caliber of profesionals that T. Rowe Price’s $1.3 trillion in assets under management can buy, it is an event worth attending. Here are five key investing insights from this year’s briefing.?

1. Stay defensive, with lots of cash in your portfolio: The big spenders in Congress have juiced the economy with stimulative fiscal policy that has butted heads with the Federal Reserve’s tight monetary policy. By the looks of third-quarter’s 4.9% U.S. GDP growth, the big spenders won.?

But that is going to change soon, which casts doubt on U.S. economic growth, predicts T. Rowe Price Chief Economist Blerina Uru?i. She says the high cost of money (now that bond yields are up so much) will discipline the big spenders and neutralize fiscal policy. That’ll remain the case for a while because yields will stay “higher for longer,” she says. “This produces risk for the economy in 2024.”

Uru?i also thinks it is too soon to declare victory over inflation. This means Fed Chair Jerome Powell won’t be going soft on interest rates any time soon, adds T. Rowe Price capital markets strategist Tim Murray. “Recovery is still in doubt until inflation is under control and we get the signal from the Fed that it will be cutting,” Murray says. “Powell keeps saying, ‘We are not cutting any time soon.’” The upshot, concludes Murray: Recovery will remain in doubt in 2024.?

There are two ways to think about this bleak view. One is to take it on face value and stay defensive, with lots of cash in your portfolio — an approach the T. Rowe Price strategists advocate.?

The other is to assume that worries about a U.S. recession will continue to be overblown, as they have been for more than a year. If recession really is off the table, the extreme caution expressed by T. Rowe Price is exactly the worry that stock market bulls want to see.?

To me, T. Rowe Price’s pessimism helps build a nice “wall of worry” for the bull market to climb. This is another way of saying if you are long stocks, you want doubters to come around and turn bullish — and drive your stocks up. Given that cautious T. Rowe Price has an enormous $1.3 trillion in assets under management, I’d say that’s the case.?

Of course, we don’t know that there will be no recession in 2024. But there’s a good case for sustained growth. Ed Yardeni, at Yardeni Research, puts the odds of no recession at 65%, citing high U.S. employment and individual savings. He likes to point out that the baby boomers command $75 trillion in net wealth.?

Yardeni is not alone.?“There is good reason to think that predictions of a recession in 2024 will prove wrong,” agrees Moody’s Analytics economist Mark Zandi. Inflation is steadily moderating without a recession, he says. Unemployment remains below 4%. Real incomes are improving as wage gains surpass inflation. Consumers have low and stable debt service burdens. Employers are extraordinarily reluctant to lay off workers, because it is hard to hire.?

2. Bad commercial real estate loans won’t blow up the economy: Refreshingly, T. Rowe Price rejects the concept of a “house view.” So, not all of its money managers and strategists are cautious across the board about the markets. Consider one portfolio manager’s benign view on commercial real estate loan risk– an issue that continues to haunt investors.?

The worry here is about the half-empty office buildings in major U.S. cities. Investors fret that lenders won’t get paid back. Then damage from loan defaults will spread, creating a credit crisis that cripples a big part of the financial system.?

T. Rowe Price portfolio manager Peter Bates recently did a deep dive on this topic, in part by meeting with several commercial real estate lenders. “My thoughts going into this were that this could be a disaster. This could spiral out of control,” he says, citing many banks’ outsized exposure to commercial real estate loans. “My conclusion is that the problem is small enough to be resolved with time.”

He cites two reasons. First, there are a lot of investors waiting on the sidelines to buy loans from banks if they’re forced to sell.

Also, bank regulators made clear last summer they’ll be flexible about making banks reclassify commercial real estate loans as problematic, a move that would force banks to back the loans with more capital. “The bank regulating body said they are going to be pretty lenient with how banks categorize these properties. That basically gives everyone time to let things work out,” Bates says. “The bottom line is commercial real estate is not going to cause the next recession.”?

Bates is worth listening to because of his solid investment track record. His global select equity strategy is up 5.2% since it was launched at the end of 2020, compared to a 2.8% gain for the MSCI World Index.?

One way to bet against the false fears about commercial real estate is to own companies that are cheap because they have a lot of exposure. Bates cites the life insurance and annuities company Corebridge Financial CRBG, +0.99%. Because insurers invest a lot in bonds, Corebridge stands to benefit from higher interest rates. “In a world with higher rates, life insurance companies are going to make a lot of money,” Bates says.

3. Invest in the U.S. infrastructure megatrend: Reshoring is real. U.S. companies are moving supply chains back home to increase reliability. Federal policy like the?Infrastructure Investment and Jobs Act authorizes more than $1 trillion dollars in construction spending. All of this creates an infrastructure spending megatrend.?

“We have underinvested in America for 20-plus years,” Bates says. “Especially with deglobalization, more dollars are going into American infrastructure.? We are going to need steel for that.” One company he believes will benefit is Steel Dynamics STLD, -1.09%. The company also gets an assist from 25% tariffs on Chinese steel imports put in place in 2018. “I don’t think we are going backwards on that,” Bates says.?

4. Go with small caps: The Russell 2000 RUT index of small- and midcap companies saw a nice 5% bounce on November 14 when lower-than-expected U.S. inflation numbers boosted the odds of higher economic growth. But so-called smid-cap stocks still look historically cheap. They are so inexpensive, they are pricing in a recession, says Murray, the T. Rowe Price capital markets strategist.

That means if a recession happens, a lot of the damage is already in the stock prices. That makes smidcaps attractive — even to people who haven’t ruled out a 2024 recession like Murray. He cautions you might need to wait two or three years for a payoff.?

5. Be especially careful now with companies that have a lot of debt: Companies did a great job of refinancing their debt at near-zero interest rates in 2020 and 2021. But debt is not forever. It comes due and needs to be rolled over. That’ll be the case soon for a lot of the cheap debt arranged two to three years go. “In 2024 and 2025 the refinance risk comes due,” cautions Steve Boothe, the head of global investment grade debt at T. Rowe Price. “A lot of that low coupon debt from 2020 and 2021 will need to be refinanced in 2024 and 2025.”

This suggests that a debt-default cycle is on the way. Boothe thinks default rates will rise from virtually zero now, to 3.5% of loans. “That is not the end of the world. But we are coming from a low base, so it will feel more painful,” he says. The default cycle is one reason T. Rowe’s capital market strategist, Murray, is cautious about the U.S. economy in 2024. But it also means that if you own stocks, you’d better understand the refinance risk.?

Michael Brush is a columnist for MarketWatch. At the time of publication, he had no positions in any of the stocks mentioned in this column. Brush publishes the stock newsletter,?Brush Up on Stocks. Follow him on X @mbrushstocks.

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