T. Rowe Price REPORT · The valuation multiples currently awarded to some of these stocks appear...

REPORTT. Rowe Price

I N S I G H T S O N I N V E S T I N G A N D F I N A N C I A L T O P I C S

The broadening global economic recovery should be supportive for risk assets in 2018, but relatively high equity valuations and low yields for credit provide limited compelling opportunities and little buffer against unexpected market events.

Given elevated valuations, further upside to equity returns in the coming year will need to be supported by continued strong growth in earnings.

Positive factors include the potential for U.S. corporate tax cuts to generate further earnings upside and for growth prospects in Europe and Japan to be sustained by durable domestic recoveries. Potential risks include a rise in geopolitical or trade tensions, as well as the possibility of a central bank policy misstep.

We expect that low yields, tight credit spreads, and less accommodative central bank policies will leave little room for upside across most fixed income sectors. Despite this environment, bonds offer beneficial attributes within portfolios to counter potential periods of heightened equity market volatility.

DiversificationOur multi-asset portfolios are designed to benefit from broad diversification across asset classes and sub-asset classes. We characteristically overweight or underweight segments of the market that we believe are more or less attractive over a 6- to 18-month investment horizon,

Improving Economy’s Benefits Challenged by High Valuations

based on various factors, including valuations and economic and earnings trends. Our overall views:

ρ Global Equities: Among developed equity markets, Europe and Japan appear more attractive than the United States, based on improving economic fundamentals, diminished political risks, and potential upside for corporate earnings. While emerging market (EM) valuations are modestly above historical averages, they appear less expensive than those in developed markets.

ρ Global Fixed Income: Sovereign yields, particularly outside the United States, remain near historically low levels, the result of continued quantitative easing by the European Central Bank and the Bank of Japan. Within high yield, floating rate loans may provide relative protection against rising rates. Within EM, select currency-denominated bonds may benefit from currency appreciation. ■

Diversification cannot assure a profit or protect against loss in a declining market. The risks of international investing are heightened for securities of issuers in emerging market countries. Floating rate loans are usually considered speculative and involve a greater risk of default and price decline than higher-rated bonds.

BY CHARLES SHRIVER, MANAGER OF THE GLOBAL ALLOCATION, BALANCED, SPECTRUM, AND PERSONAL STRATEGY FUNDS

ISSUE NO. 138 WINTER 2018

ANNUAL OUTLOOK ISSUE

2 Global Economy: Synchronous Global Expansion

3 U.S. Economy: Employment Gains and Moderate Growth

4 Global Equities: Innovation Triggers Market Disruption

6 U.S. Equities: As This Bull Ages, Cautious Expectations

8 Global Fixed Income: Low Yields and Tight Valuations

10 Europe: Economic Recovery But Some Risks Linger

12 Emerging Markets: Despite Gains, Opportunities Exist

14 Tax-Efficient Investing: Don’t Overlook the Impact of Taxes

16 Last Word: Parents Prioritize College But Favor Their Sons

QUARTERLY PERFORMANCE UPDATE

17 Equity Market Review

Fixed Income Market Review

Fund Performance Tables

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GLOBAL ECONOMY

Global Expansion Provides a Solid Footing for 2018 World EconomyFewer imbalances leave world well prepared for less monetary stimulus.

BY NIKOLAJ SCHMIDT, T. ROWE PRICE CHIEF INTERNATIONAL ECONOMIST

Global growth solidified in 2017, with all major regional economies accelerating in unison for the first time in almost a decade. The pickup in growth was most impressive among commodity exporters, such as Brazil, Mexico, and Russia, but Japan and major developed economies in Europe also performed well.

Although we expect that growth will decelerate in 2018, the global economy should carry much of its momentum into this year.

While China’s surprising resilience deserved most of the credit early in 2017, the global economy’s strong showing recently has been due largely to a rebound in capital goods expenditures (see Figure 1, page 3).

Energy- and metals-related investment, in particular, has provided an important boost not only to emerging market exporters, but also to Germany, the United States, and other major developed markets. Global trade has accelerated alongside increased capital spending.

Reduced imbalancesIt is particularly encouraging that growth in Europe has become more self-sustaining and less vulnerable

to imbalances. With unemployment down and incomes growing, European consumers are beginning to unleash several years of pent-up demand, putting the Continent squarely in the early stages of a cyclical recovery. European consumers have been somewhat vulnerable to higher oil prices, but the energy environment remains benign compared with earlier in the decade.

In Japan, “Abenomics” continues to show signs of progress. Labor shortages have emerged as Japan’s unemployment rate has declined to a 23-year low, and the ratio of jobs to applicants has climbed to its highest level since 1974. While broad-based wage increases remain modest, workers are moving to higher-paid positions.

We expect China’s growth rate to slow in 2018, but we are optimistic that its leaders can keep the economy expanding at a pace that does not threaten growth for its trading partners. The country’s leadership has shifted its focus from topline growth to boosting China’s quality of life. Even as they pursue this new “China Dream” plan, Chinese officials are likely to step in with accommodation to meet their promise of doubling incomes over the current decade—implying an average annual growth rate of 6.3% until 2020.

Chinese officials also have been adept to date at tightening regulation in the financials sector without strangling credit growth in the real economy, but the possibility that they may move too aggressively is one of the major risks to our outlook.

Liquidity withdrawalMore broadly, the withdrawal of global central bank liquidity may be the main test facing financial markets in 2018. While only the Federal Reserve, the Bank of England, and the Bank of Canada have begun raising rates, a number of central banks in developed markets will take the first steps in reducing monetary accommodation.

We currently expect the European Central Bank to wind down its asset purchases by the end of 2018, with rate hikes probably following in 2019.

When the Bank of Japan (BoJ) will make the turn away from accommodation remains less certain,

but we expect moderation next year in the thrust of policy stimulus. The BoJ is likely to declare the end of deflation in the relatively near future, which it likely would follow with a reduction of its stock purchases.

The wind-down of central bank balance sheet expansion should not necessarily pose a significant headwind to global growth. Worldwide, quantitative easing—not tightening— will continue through 2018, if at a reduced pace: from roughly $2 trillion in 2017 to $500 billion in 2018.

Moreover, the slowdown in accommodation will come against the backdrop of a much more balanced global economy. ■

The wind-down of central bank balance sheet expansion should not necessarily pose a significant headwind to global growth.

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U.S. ECONOMY

Moderate Growth Path for Economy as Unemployment Continues to FallTighter U.S. labor markets are likely to lift wage growth and solidify gradual inflation uplift.

BY ALAN LEVENSON, T. ROWE PRICE CHIEF U.S. ECONOMIST

After some modest volatility in the first half of 2017, the U.S. economy appears to be settling back into the moderate growth path that it has followed over the past several years.

We expect growth to run at an annualized rate of about 2.5% in early 2018, fed by moderate gains in nominal wages, the recent pickup in capital expenditures, and a roughly quarter-point boost from December’s

tax cuts. Inflation appears to be stalled at around 2%, which should keep the Federal Reserve on its current gradual tightening path.

Growth statistics for the third quarter of 2017 seemed to show little impact from the hurricanes in August and September, with annualized gross domestic product growth of 3.2% nearly matching its second-quarter pace.

Inventory building and an increase in net exports helped compensate for the hurricanes’ impact on manufacturing and consumer spending. Business purchases of non-transportation equipment—a good measure of core capital spending trends—accelerated in the third quarter (see Figure 1).

The hurricanes seemed to have little lasting impact on the overall labor market. Indeed, the unemployment rate has now fallen below its trough during the moderate expansion of the previous decade.

We expect the economy to overshoot full employment in the coming months, even as job gains slow, with the unemployment rate falling to 3.7% by the end of 2018—

below even its trough during the robust expansion of the late 1990s.

Nevertheless, we are skeptical that a tightening labor market will lead to sharply higher nominal wage growth and push the economy out of its low inflation and moderate growth track. Productivity growth remains well below its levels in the 1990s.

Aside from the housing sector, most segments of the economy are seeing minimal price pressures, while the durable goods segment continues to experience outright deflation, fed by global competition, automation, and other pressures.

As a result, it seems increasingly plausible that inflation may not reach the Fed’s target of 2% in the personal consumption expenditures price index in the current cycle. Notably, policymakers have recently revised inflation forecasts to show a later arrival of inflation at the 2% target.

The FedMessaging will become a larger challenge for monetary policymakers if inflation continues to disappoint, but we do not expect the Fed to stop raising rates in response.

Fed officials are aware that abnormally low long-term interest rates are fostering inflated asset prices and may pose risks to financial stability if they are sustained. Thus, the Fed is likely to tolerate sub-2% inflation while nudging rates higher, at least until the unemployment rate stabilizes.

While the recent nomination of Jerome Powell as Federal Reserve chair signals little change in rate policy, the new chair may loosen regulations for small banks. But we caution that investors should not expect Powell to be an advocate for wholesale deregulation. ■

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Figure 1 Capital Expenditures Drive Global Acceleration Developed Markets’* Capital Goods Shipments and Retail Sales

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In 2018, we expect a further acceleration in the disruptive forces being unleashed in global equity markets by a powerful combination of technological innovation, changing consumer preferences, and evolving business models. These forces are upsetting the competitive balance in existing industries, while at the same time spurring rapid growth for new products and services.

This wave of change should continue to benefit a small group of mega-cap companies that have created dominant technology platforms in such industries as e-commerce, social media, mobile devices, and Internet search. Key advantages—including large user bases, massive computing power, skilled workforces, and ample financial resources—have allowed these companies to leverage powerful economies of scale, sustaining rates of growth that are almost unprecedented given their current size.

The valuation multiples currently awarded to some of these stocks appear justified by their growth potential—although we recognize the need to differentiate between companies with high current cash flow and earnings and those that are largely reinvesting in their businesses. Looking ahead, we see two key trends worth watching in 2018:

ρ The scope of disruption is expanding. While retail, advertising, and consumer electronics have been the most visible arenas for disruption so far, advances in genetic mapping are driving the development of new drugs, and horizontal drilling technology has pushed global oil prices sharply lower. Such technologies as electric vehicles and autonomous driving suggest that transportation industries could be next in line for rapid transformation.

ρ Political attitudes are changing: Until recently, the technology giants have been widely admired for the benefits—selection, convenience, low prices—they have delivered to consumers. However, data privacy and security concerns and controversies about social media’s role in recent elections have raised questions about corporate governance and how these firms wield their economic power. This creates the potential for a regulatory backlash.

Opportunities for profitable growth—both organically and through acquisitions—should remain plentiful for these winners as they extend their brand power and distributional control across markets and geographic regions. However, the political climate for these companies will bear watching in 2018.

Economic outlookFor the first time since the 2008–2009 financial crisis, the global economy appears to have entered a synchronized expansion. Strong growth, ample liquidity, and low inflation have produced an extended period of exceptionally low volatility—not just in global equity markets, but in credit and currency markets as well.

While it remains to be seen whether this period of calm will persist in 2018, we would not necessarily view it as forecasting a correction. T. Rowe Price’s research suggests that periods of low market volatility can resolve themselves to either the upside or the downside.

Similarly, valuation multiples that are above historical averages in most developed markets do not necessarily mean global equities are overvalued. In the context of low interest rates and low inflation, equity risk premiums in many markets still appear reasonable.

A key question in 2018 will be whether strong growth and tightening labor markets will generate typical late-cycle inflationary pressures, forcing the major central banks into a more aggressive withdrawal of monetary stimulus. Current market expectations are for a continued gradual pace of Federal Reserve tightening and for the European Central Bank to begin a moderate tapering of its bond purchases. The Bank of Japan (BoJ) still appears committed to its own version of quantitative easing.

These policies would be constructive for equities. However, considering the potential for faster growth and tighter labor markets, we are mindful of the risk of upside inflation surprises.

KEY POINTSρ Innovation and disruptive change continue to benefit a

relatively small group of mega-cap companies. Despite recent gains, valuations for these stocks still appear reasonable.

ρ For the first time since the global financial crisis, the world economy is in a synchronized expansion, driving steady earnings growth in most markets.

ρ Barring unpredictable political or economic shocks, the global earnings recovery should continue in 2018. However, year-over-year comparisons will grow more challenging.

ρ Whether recent low market volatility persists in 2018 remains to be seen, but we do not believe low volatility in itself predicts a significant correction is imminent.

GLOBAL EQUITIES

Innovation Unleashes Disruptive Forces in Global Equity MarketsBarring shocks, the global earnings recovery should continue, though earnings momentum may slow.

BY ROB SHARPS, GROUP CHIEF INVESTMENT OFFICER, AND JUSTIN THOMSON, CHIEF INVESTMENT OFFICER, EQUITY


EarningsTo a large extent, equity strength in 2017 reflected a broad-based recovery from the global profits recession that began in the second half of 2014 (see Figure 1). In Europe, earnings revisions turned positive for the first time since 2012. U.S. earnings momentum also appeared to reaccelerate. Meanwhile, Japanese companies generally did well despite a steady to stronger yen.

Faster-than-expected growth in China—despite tighter money and credit as Beijing addresses the country’s bad debt problems—was in many ways the economic surprise of 2017. With China acting as the locomotive for the Asian economies, the broader earnings recovery in emerging markets also accelerated.

Barring unpredictable political or economic shocks, the global earnings recovery should continue in 2018; however, year-over-year growth comparisons will grow more challenging. We believe markets will weather slowing earnings momentum as long as investors perceive that the underlying growth trends are positive and can be sustained as the economic cycle continues to mature.

U.S. tax reformWith tax reform legislation approved by Congress in late 2017, many multinational firms entered the year evaluating how the revamped U.S. corporate tax code could impact their businesses.

In addition to boosting after-tax reported earnings, the significant reduction in the corporate income tax rate could spur capital spending and hiring, potentially giving a second wind to earnings growth.

In terms of economic sector performance, much still depends on whether U.S. fiscal stimulus leads to a further acceleration in the global economy in 2018. If so, the “reflation trade” favoring cyclical value could be revived, although such rate-sensitive

sectors as real estate investment trusts, utilities, and consumer staples potentially would be challenged. On the other hand, if economic momentum slows, secular growth could regain favor.

RegionsEmerging markets generally outperformed in 2017, while the ex-U.S. developed markets, as measured by Morgan Stanley Capital International’s Europe, Australasia, and the Far East Index, outperformed U.S. equities in U.S. dollar terms. Our regional perspectives include:

ρ United States: After lagging secular growth stocks through much of 2017, cyclical sectors showed some strength in the second half, perhaps reflecting growing optimism about U.S. fiscal stimulus. U.S. corporate tax cuts should tend to favor U.S. small-caps, which are more exposed to the domestic economy and are more heavily taxed on average than their large-cap counterparts.

ρ Europe: Financials, energy, and materials are heavily weighted in the major European indexes, so higher interest rates, a steepening yield curve, and/or a more sustained recovery in commodity prices all would be constructive for earnings.

ρ United Kingdom: The exception to a generally positive European picture is the UK, where there are growing signs of financial stress—in the London property market, for example. The longer Brexit negotiations go on without meaningful progress, the more hiring and investment decisions are likely to be put on hold, increasing the risk of a downturn.

ρ Japan: Japanese equities historically have been highly sensitive to the global economic cycle. With the BoJ focused on managing the long end of the yield curve, a combination of strong export demand and a weaker yen potentially could be very supportive for equities. Continued corporate reform and a shift to more shareholder-friendly policies are additional positives.

ρ China: We continue to focus on China’s domestic technology titans, as recent equity performance has been even more concentrated in those names than it has in the U.S. market. However, structural reform of state-owned enterprises could create future opportunities in basic industries.

ρ Other Emerging Markets: Lagging economies in Brazil and Russia have stabilized, and asset prices have been strong. India was the one major negative surprise in 2017, as demonetization caused temporary shocks, aggravated by bad debt burdens. Recent moves to address the debt situation will help. ■

All investments are subject to market risk, including the potential loss of principal. Non-U.S. securities are subject to the unique risks of international investing, including currency fluctuations. Past performance cannot guarantee future results.

Figure 1 Synchronized Global Growth Boosts EarningsEarnings Per Share, Local Currency Terms

Sources: FactSet, Standard & Poor’s, and MSCI; data analysis by T. Rowe Price. Additional disclosures on page 24.

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The U.S. equity bull market that began in the wake of the global financial crisis has surely exceeded the expectations of many investors. While the fundamental underpinnings for equities remain positive and should support continued gains, investors should temper their expectations given the likelihood of more muted returns amid potentially greater volatility.

Consumer surveys by the University of Michigan show optimistic forward expectations for stock prices even as they reach all-time highs, leaving little room for error.

To be sure, the general economic backdrop remains constructive with improving global growth. U.S. economic growth has improved and could get a modest boost from the recently approved tax cuts. Consumer and corporate balance sheets and the housing market are generally healthy. Inflation remains tame for now. Business investment is improving.

Earnings outlookCorporate earnings rebounded in 2017, and consensus analyst forecasts project them to remain on a growth path over the next couple of years, particularly for technology and health-care companies. However, these estimates are elevated, so it may be

difficult to achieve upside surprises. The risk of earnings misses also is greater.

If labor markets tighten further, earnings could be pressured by declining profit margins as wage growth accelerates. The rigorous corporate cost-cutting seen in recent years may leave little additional room to protect margins if price competition and/or wage pressures intensify. Greater dollar strength could undermine profits for U.S.-based multinationals, which would see a decline in the value of their foreign earnings.

Profit margins already are near peak levels as margin expansion has thus far accounted for a greater proportion of earnings growth in this cycle than revenue growth. So rising revenues will be needed to offset margin declines, drive earnings growth, and support valuation multiples.

Many investors are expecting that the new corporate tax cut will boost after-tax earnings. Lower corporate tax rates should be particularly beneficial for small companies, which tend to have higher tax rates and are more domestically oriented than larger firms, as well as for other U.S.-based firms that derive most of their earnings from U.S. markets.

Monetary policyWhile the Federal Reserve is expected to continue raising short-term rates in 2018, the pace of that tightening will be sufficiently gradual—such that it does not pose a big threat to equities as long as economic growth remains moderate.

Historically, rising rates have coincided with rising stock prices when the 10-year Treasury yield has remained below 5%. Importantly, rising rates signal an improving economy, which should be supportive for valuations and earnings.

However, if the Fed overshoots or does not continue to communicate its intentions clearly, volatility could spike. Investors currently appear to anticipate lower inflation and more modest long-term growth than the Fed is projecting and, therefore, lower cumulative rate increases than the Fed is indicating.

While lower taxes can be helpful to smaller companies, higher rates could be a hindrance, as they have generally taken on more leverage in this cycle than larger companies. Although corporate leverage has increased broadly, balance sheets generally remain healthy and flush with cash, which could enable companies to increase capital spending, fund mergers and acquisitions, and return more capital to shareholders.

SectorsMore adverse environments are rarely telegraphed and are naturally harder to predict, though elevated stock valuations are one reason to take a more cautious approach (see Figure 1). Many market sectors are fully valued relative to their long-term historical averages, particularly financials, consumer staples, and utilities. Although information technology and health care outperformed the broader market in 2017, their relative

KEY POINTSρ Investors should temper expectations for equity returns

of the aging bull market amid elevated valuations and peak profit margins.

ρ At the same time, continued economic growth, rising earnings, healthy consumer and business balance sheets, and tax reform could support further market gains.

ρ Although technology and health care have outperformed, their relative valuations still appear reasonable and earnings projections remain strong.

ρ While investors face risks, we are optimistic on the outlook for large- and small-cap stocks.

U.S. EQUITIES

An Aging Bull Market: Elevated Valuations Temper ExpectationsYet continued growth, rising earnings, and healthy balance sheets could mean gains.

BY ANN HOLCOMB, MANAGER OF THE CAPITAL OPPORTUNITY FUND


valuations remained below historical averages. Both sectors have strong fundamentals.

Following a period of underperformance, relative valuations for small-cap stocks compared with large-cap stocks moved in line with historical averages in 2017. This, along with an improving domestic economy, suggests a more positive environment for small-caps.

Similarly, relative valuations continue to favor growth sectors over more cyclically sensitive, value-oriented stocks, but these differences have grown less pronounced following a period of growth stock outperformance led by a narrow group of technology and consumer-related companies.

OpportunitiesWhile market valuations appear relatively full, we believe the firm’s fundamental, bottom-up approach to security selection and long-term investment horizon will enable portfolio managers to find investment opportunities across the market in 2018. Areas of current focus include industries undergoing significant change and companies selling below their intrinsic value. Moreover:

ρ Some technology companies should be able to drive growth even in a relatively sluggish economic environment by leveraging their dominant positions in such innovative fields as artificial intelligence and cloud computing.

ρ The health-care sector rebounded in a more supportive regulatory environment in 2017, thanks in part to what appears to be a more thoughtful, value-based approach to reducing drug prices and less onerous processes for federal new drug approvals. Biotech companies with healthy drug pipelines should benefit.

ρ Financials should benefit from higher interest rates and increased leeway to return capital to shareholders via stock buybacks and dividend increases.

RisksIn addition to somewhat extended equity valuations, other potential risks to the 2018 outlook include: a sharper-than-expected rise in interest rates, geopolitical shocks, a decline in profit margins accompanied by subdued revenue growth, and the potential inability of Washington to pass such growth-oriented policies as infrastructure spending. Protectionist trade policies and continued uncertainty about health-care policies also are risks.

On the other hand, the conditions that typically have fostered past bear markets—such as an impending recession, falling consumer confidence, and sharply higher borrowing costs—do not seem imminent. However, given the level of uncertainty and potentially greater volatility amid possibly excessive optimism, investors should have more realistic expectations.

As always, investors should take a long-term view and focus on companies with durable earnings, free cash flow growth, and reasonable valuations. A focus on quality and diversification can help manage risk.

On balance, we remain optimistic as to the outlook for both large- and small-cap stocks but suggest a cautious approach given fuller valuations and peak profit margins. If risks on the horizon become magnified, the long-standing bull market may struggle to maintain its momentum. However, bull markets do not die of old age, and if economic and earnings growth are sustained in 2018, further market gains would not be surprising. ■

All investments are subject to market risk, including the potential loss of principal. Diversification cannot assure a profit or protect against loss in a declining market.

Figure 1 U.S. Equity Valuations Elevated Relative to HistoryForward Price-to-Earnings (P/E) Ratios, December 2002 Through December 2017

P/E ratios are based on FactSet Market Aggregates. Sources: FactSet, Russell Investments, and T. Rowe Price. Additional disclosures on page 24.

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This year likely marks the beginning of a new era in bond investing as central banks begin the long process of withdrawing the quantitative easing (QE) measures introduced in the wake of the global financial crisis and as some monetary policymakers also are set to hike interest rates.

These tightening measures come at a time when sovereign yields in developed markets are very low, credit spreads are tight, the global economy faces trade uncertainty, inflation may return, and there are geopolitical risks. However, growth will remain firm in many parts of the world, creating compelling opportunities in selected credit sectors.

In this environment, bond investors will need to cast a wider net and diversify their fixed income portfolios to meet their desired risk and return objectives, with an emphasis on detailed research, active security selection, and sector rotation.

Central banksLast year arrived amid high expectations that newly elected U.S. President Donald J. Trump’s proposed infrastructure spending, tax cuts, and regulatory reforms would result in higher U.S. growth and inflation. It did not take long for these expectations to fade.

When it became clear that Trump’s policies would prove much harder than anticipated to put into practice, yields fell back down to levels last seen before the presidential election, interest rates declined, and the dollar slumped against the euro. Since then, interest rates have modestly picked up and the dollar has rallied slightly, but uncertainty persists over the extent to which Trump can deliver on his promises.

A bigger influence on markets in 2018 than President Trump’s political fortunes, however, will be the extent and speed of central bank tightening. Following almost a decade of unprecedented monetary stimulus, central bank-owned assets equaled 45% of global gross domestic product at the end of August, compared with about 20% immediately prior to the 2008 financial crisis. This figure should fall as central banks begin the long process of retrenching their balance sheets, but it is not yet clear how quickly they will seek to do this or what the cumulative impact on markets will be.

Some central banks also will hike interest rates in 2018—possibly more aggressively than currently priced in by the markets. The market currently expects the Fed to raise U.S. rates three times in 2018, which would take the federal funds rate to 2.25% and—if long-term rates remain stable—flatten the U.S. Treasury yield curve.

If the Fed hikes more than that or seeks to reduce its balance sheet more quickly than anticipated, the U.S. yield curve could even become inverted. Based on past experience, this would imply a negative outlook for the U.S. economy. If the Fed proceeds more cautiously, however, a reasonable rate of economic growth should be achievable.

Europe remains at an earlier stage in the credit cycle than the United States (see Figure 1), with reasonable growth prospects for 2018. The European Central Bank has signaled its intention to begin tapering its bond purchase program in 2018, but it is unlikely to begin raising interest rates until 2019.

Although the eurozone yield curve also is likely to flatten, it is unlikely to invert. Elsewhere, however, there are growing expectations that the Bank of England will raise rates more quickly than anticipated to curb inflation, and the Bank of Canada appears likely to move into an aggressive cycle of rate hikes.

A tightening move by one central bank in isolation would probably not cause too much concern; a number of banks doing so at the same time is a very different proposition. Developed market yields remain close to record lows, while credit spreads are tight on the back of years of accommodative monetary policies and benign economic conditions. Synchronized tightening in this environment could be disruptive. However, banks are likely to adopt a cautious approach, so liquidity will very probably remain ample for an extended period.

The key question, therefore, is which factor is more important—the flow of QE (which will be negative) or the remaining stock of QE (which should still be very substantial)? How the markets

KEY POINTSρ Developed markets’ central bank tightening is set to

begin in earnest in 2018, ending an almost-decade-long period of monetary stimulus.

ρ Monetary tightening will take place against a background of low yields, tight valuations, the possibility of inflation, and a number of ongoing geopolitical risks.

ρ However, we believe growth will remain firm in many parts of the world, creating compelling opportunities in selected credit sectors.

ρ In this environment, it may pay to employ barbell strategies that combine higher-yield assets with assets that have lower correlation to equities.

GLOBAL FIXED INCOME

Backdrop of Low Yields and Tight Valuations as Central Banks TightenBut generally firm global growth creates compelling opportunities in certain sectors.

BY MARK VASELKIV, CHIEF INVESTMENT OFFICER OF FIXED INCOME


answer this question will play a major part in determining whether 2018 sees a return to volatility.

Risks vs. growthUncertainties over trading relationships and Chinese growth pose further challenges. If the negotiations between the United Kingdom and the European Union over Brexit collapse or President Trump delivers on his threat to scrap the North American Free Trade Agreement, the restrictions on trade that would likely ensue could negatively impact global growth.

Chinese authorities are expected to ramp up their efforts to reform China’s state-owned enterprises and reduce corporate debt, which could slow the Chinese economy in 2018. China’s growth is still expected to come in above 6%, but a downside surprise could cause significant disruption.

Geopolitical risks persist, too. Tensions between the United States and North Korea show no sign of abating. While full-scale war seems unlikely given the costs on both sides, the potential impact of the diplomatic standoff on U.S.–China relations is a concern.

Elsewhere, the threat to European unity has receded following the failure of populist, anti-immigration parties to make major inroads in the Dutch, French, and German elections. But the Catalan independence movement in Spain and ongoing negotiations over Brexit have the potential to unleash further volatility, as has the forthcoming Italian general election.

In addition, while under control for a number of years, inflation may make a comeback in 2018. The broader economic environment continues to show improvement, and there is

a possibility that central banks may misinterpret underlying inflation signals and stresses.

DiversificationLast year was notable for the tranquility of the markets—bad news came and went without causing too much disruption. Efforts to hedge portfolios against risks generally did not pay off, hampering the returns of investors who opted to tread carefully.

As noted, whether the markets remain as nonchalant in 2018 will depend largely on how investors respond to the beginning of the withdrawal of monetary stimulus. We believe it is very possible that a risk event, or a combination of events, could unleash considerable volatility, making it prudent for investors to manage risk exposure by adopting underweight positions or adding risk-free assets like U.S. Treasuries to their portfolios.

Diversification also will be key. While sovereign yields in the developed markets are low, some emerging markets are at different stages in their interest rate cycles and offer higher sovereign yields. High yield bonds and bank loans appear to offer better return potential and lower duration than developed sovereigns, but they do not appear cheap in the current environment and also are highly correlated to equities—meaning they could be vulnerable in the event of a market correction.

We believe a barbell strategy—one that pairs credit instruments with asset-backed securities or sovereigns (which historically have been less correlated with equities)—may offer advantages in 2018. Another potentially promising approach could be to invest in countries undergoing positive transformational change, such as Argentina, India, and Indonesia.

More generally, given the potentially volatile nature of markets, a willingness to adopt an active approach to security selection and rotate between sectors where necessary could be advantageous for bond investors in 2018. ■

Diversification cannot assure a profit or protect against loss in a declining market. Yields can vary with interest rate changes, and certain bond holdings are subject to credit risk. International investing, particularly in emerging markets, entails additional risks, including currency and political risks.

Figure 1 Divergence Offers OpportunitiesCountries’ Positions Vary Along the Interest Rate Cycle*

*As of December 31, 2017. Sources: CRB Rates and T. Rowe Price.

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IsraelEurozone UK

CanadaHungary

Philippines

U.S.

China

Hong Kong

MexicoTurkey

EgyptArgentina

Developed CountriesDeveloping Countries

...given the potentially volatile nature of markets, a willingness to adopt an active approach to security selection and rotate between sectors where necessary could be advantageous for bond investors in 2018.

10


Underpinned by strong fundamentals, the European economic recovery should continue in 2018, providing support for the Continent’s equity and bond markets. However, lingering political risks, the prospect of central bank tightening, and stretched valuations mean that periods of volatility cannot be ruled out.

Investors could be rewarded by adopting a highly selective approach, with an emphasis on identifying strong companies within sectors that appear likely to benefit from the European recovery but potentially could be less exposed to periods of market instability.

Populism Following the United Kingdom’s watershed decision to exit the European Union (EU), the established order in Europe seemed under threat from populist movements in a number of countries in 2017. Elections in the Netherlands, France, and Germany, and a planned unofficial referendum on independence for Catalonia from Spain, were all seen as potential flashpoints that could challenge the EU’s attempts at closer integration.

In the end, mainstream parties prevailed in the Netherlands and France, but anti-immigration, anti-EU candidates made some headway in Germany and in Austria’s early election.

And although the Catalan pro-independence movement is being driven more by long-standing regional grievances against the Spanish government than by anti-immigration or anti-EU sentiment, the issue still could play a decisive role in influencing other separatist movements in Europe.

Despite these risks, the eurozone grew at a healthy rate throughout the year—consistent with economies in other parts of the world that proved similarly impervious to negative geopolitical events. The big question for 2018 is whether this resilience will continue.

At a fundamental level, the prospects look good: Europe is at an earlier stage in the credit cycle than the United States, corporate earnings are strong, and the recovery seems to be sufficiently broad-based to sustain itself.

Risks remain, however. While the threat from anti-EU and other separatist forces has abated, it has not disappeared. The situation in Catalonia could take a while to resolve, the euroskeptic Five Star Movement and Northern League parties both are expected to perform well in the Italian general election due in March, and negotiations over Brexit could yet collapse.

Moreover, the possibility remains that other member states will seek to leave the EU or that populist movements will gain stronger footholds in their national parliaments, influencing policy. Any such developments would be regarded as threats to EU unity.

ECB The prospect of central bank tightening is another potential risk to the 2018 outlook. In October, the ECB announced plans to scale back its monthly asset purchase program from €60bn to €30bn beginning in early 2018 but clarified that it would continue reinvesting the proceeds of its bond purchases for “as long as necessary” to support growth. It also said it would not raise rates until after its bond purchases have been ended.

We believe the ECB’s announcement suggests that monetary policy in the eurozone will remain highly accommodative for the next few years at least, which is good news for investors concerned about the vulnerability of the European recovery. However, if the eurozone economy expands more quickly than expected, the ECB could be forced to tighten more aggressively, which would risk putting upward pressure on credit spreads.

Elsewhere, the U.S. Federal Reserve is expected to raise rates three times in 2018 and adopt a fairly moderate approach to shrinking its balance sheet, but the pace could change depending on growth and inflation data. If the Fed surprises the markets with more aggressive tightening, any subsequent spike in volatility also could affect the recovery in Europe.

KEY POINTSρ The European economic recovery should continue in 2018,

supporting the Continent’s bond and equity markets.

ρ However, lingering political risks, the prospect of European Central Bank (ECB) tightening, and stretched credit valuations mean possible periods of volatility.

ρ In equities, there are potential opportunities in high-quality, growth-generating companies that are well placed to benefit from Europe’s economic recovery.

ρ The most effective approach to active bond selection may be to identify corporate issuers whose “stories” are likely to improve irrespective of how credit benchmarks perform.

EUROPEAN MARKETS

Economic Recovery to Persist in the Face of Lingering RisksInvestors could be rewarded by identifying strong companies positioned to benefit from the recovery.

BY DEAN TENERELLI, MANAGER OF THE EUROPEAN STOCK FUND, AND MIKE DELLA VEDOVA, A GLOBAL HIGH YIELD BOND MANAGER


Growth stocksInvestors in European equities benefited from rising corporate earnings throughout 2017 on the back of the strong fundamentals and diminishing concerns over political risk (see Figure 1).

We expect earnings growth to be slower in 2018 and in 2019, mainly due to a stronger euro and the difficulties some companies could have offsetting input cost pressures from higher raw material prices. However, as many other asset classes appear to be fully valued, further upside to European equities is possible if corporations continue to build on their recent solid growth.

The best European equity opportunities in 2018 are likely to be found in high-quality, growth-generating companies that are well placed to benefit from the economic recovery.

The telecommunication services sector is particularly interesting in this regard because consolidation is driving competition and boosting margins. European banks are generally undervalued and stand to benefit from the gradual removal of monetary stimulus by the ECB. However, we do not expect financial stocks to outperform significantly in 2018 as interest rates are unlikely to rise appreciably.

We also see potential opportunities in the software services industry, where a number of companies are innovative disruptors and are delivering excellent rates of compound growth. Although we do not generally favor automakers given their expensive valuations, regulatory issues, and complex financing structures, opportunities can be found among the industry’s suppliers—particularly original equipment manufacturers using innovative technologies to develop irreplaceable parts.

Our focus on growth has led us away from such defensive sectors as consumer staples, which have fallen out of favor with the market more broadly. However, these sectors have become cheaper recently and opportunities may arise if valuations fall further, as a number of companies offer good earnings growth, strong returns, and healthy dividends.

Low yieldsStrong corporate fundamentals meant that European credit markets also performed well in 2017. The ECB’s huge monetary stimulus program played a major role in supporting the rally by making it cheaper than ever for corporations to borrow and by reducing default risk to record-low levels, encouraging investment.

However, lower risk also has brought lower returns. Monetary stimulus has compressed yields, although the rewards available in European credit markets have been better than in many other markets. Assuming the ECB keeps its pledge to adopt a cautious approach to tapering, we believe that European corporate debt markets will deflate rather than burst and that yield curves will rise only gradually in 2018.

Given the risk of holding low-coupon securities at a time when political risks are present and central banks are seeking to remove monetary accommodation, a sensible approach for investors is to seek to identify corporate issuers whose individual “stories” have the potential to improve irrespective of how credit benchmarks perform. This strategy may lead to underperformance during market rallies, but over the longer term, it is likely to be a more effective way of navigating a period of monetary tightening and market volatility.

Attractive European high yield issuers currently include media, cable, telecommunications, and packaging companies, all of which appear well positioned from both a cyclical and a secular perspective.

The most promising opportunities within investment-grade debt can be found in broadly the same sectors and among financial companies, which form a much bigger part of the investment-grade universe. The new capital rules put in place after the 2008–2009 financial crisis now are being tested—and so far they seem to be working. If this continues, we believe European financial debt issues can perform strongly again in 2018. ■

All investments are subject to market risk, including the potential loss of principal. Non-U.S. securities are subject to the unique risks of international investing, including currency fluctuation. Bonds are subject to risks from rising interest rates, credit rating downgrades, and default. These risks are heightened for investments in a single region. Past performance cannot guarantee future results.

Figure 1 European Earnings Held Up in 2017Estimates Over Time, Year Over Year

*MSCI Europe Index (Euros). Sources: MSCI and Morgan Stanley. Additional disclosures on page 24.

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12


Global emerging markets (EMs) continue to offer attractive investment opportunities even after the strong performance seen in 2017.

Many of these markets are in much better shape today, boosted by the ongoing progress of meaningful economic and political reforms in key developing countries. Many of their traditional vulnerabilities, such as large current account deficits and low inflation-adjusted interest rates, have markedly improved.

After 2017’s strong performance, valuations for both equities and bonds are not as compelling as they were a year ago. However, they remain attractive relative to their history and to most developed markets.

Importantly, they do not reflect EMs’ contribution to the global economy and to overall growth. In fact, we would view a pricing dislocation triggered by an event in developed markets as an opportunity to broadly add to EM debt at lower valuations.

EM growthBroadly speaking, economic growth in EMs outpaced developed markets growth in 2017.

This stronger growth should continue in 2018 as such countries as Brazil, Russia, and India improve, widening the growth advantage for EMs over developed markets. This supportive economic backdrop should allow for further gains in corporate earnings, which recovered strongly in 2017.

Furthermore, many companies continue to undertake steps to control costs and improve profit margins. Importantly, margins have more room to improve, as they remain below historical averages in most emerging countries. Also, more disciplined capital spending is contributing to a strong recovery in cash flows, which should help support increases in dividends.

EM equity valuations, as measured by price-to-earnings ratios, still look competitive versus developed markets and their own historical levels, even if they are not as cheap across the board as they were a year ago (see Figure 1).

Here’s more detail by region:

ρ Asia: Emerging countries in Southeast Asia are leading the way in enacting reforms and correcting the fundamental imbalances that made them vulnerable in past financial crises.

India and Indonesia, in particular, have made notable progress implementing needed reforms. Capital flows into these countries were unexpectedly strong in 2017, while inflation was contained—helping them improve their current account balances. This should help their economies achieve more sustainable growth.

While geopolitical tensions involving North Korea continue to present a risk, stable growth in China has been a key factor in supporting other EMs, particularly Asian economies closely linked to the Chinese supply chain.

As China addresses overcapacity in some of its industries, tackles true reform of its state enterprises, focuses on improving quality of life, and works through its buildup of debt, its growth could slow modestly. Additionally, concerns about potential instability in the Chinese financials sector from the country’s growing debt have eased.

ρ Latin America: While volatility is likely to remain in the short to medium term for some Latin American countries, we see attractive long-term equity investment opportunities in the region, even after the market gains of the past year.

Latin American countries are benefiting from a broad shift toward political leaders who tend to implement investor-friendly policies. For example, Argentine President Mauricio Macri, elected in 2015, already has made significant progress on meaningful reforms and looks likely to win reelection in 2019.

KEY POINTSρ Emerging markets (EM) equity valuations appear

competitive versus developed markets and their own historical levels, although not as cheap as a year ago.

ρ Although yields on EM bonds have compressed, the asset class still offers broadly healthy fundamentals as well as attractive yields relative to historical volatility.

ρ Alongside a sharp China slowdown or a Korean Peninsula conflict, external 2018 EM risks include the withdrawal of quantitative easing or a downward commodity price shock.

ρ Active management lets equity investors focus on attractive pockets of EM growth and allows debt investors to invest in countries that are not in their benchmark.

EMERGING MARKETS

Opportunities Available Even After a Strong Performance in 2017Many key developing markets have been boosted by progress in meaningful economic and political reforms.

BY GONZALO PÁNGARO, MANAGER OF THE EMERGING MARKETS STOCK FUND, AND SAMY MUADDI, MANAGER OF THE EMERGING MARKETS CORPORATE BOND FUND


On the other hand, we remain cautious toward Mexico because of the twin risks of the United States renegotiating the North American Free Trade Agreement and a potential victory for leftist candidate Andres Manuel Lopez Obrador in Mexico’s July 2018 presidential election.

Although continued political corruption scandals have knocked reform momentum in Brazil off course, optimism that President Michel Temer’s administration will eventually accomplish meaningful structural reforms has contributed to an impressive rally as the country’s economy shows signs of recovering from its deepest recession in 100 years.

ρ Emerging Europe: Countries in emerging Europe are broadly behind other EM regions in terms of their willingness and ability to make meaningful reforms. The governments of Russia and Turkey are key laggards.

However, Russia enjoyed impressive domestic demand-led growth in 2017. Russia’s central bank continues to have room to cut interest rates amid moderate inflation, which could bode well for growth and both bonds and equities.

External risksUnlike in the past, when internal political or economic problems were most typically the triggers for sell-offs in EMs, today the primary risks for these markets are mostly external.

However, while unexpectedly hawkish monetary policy in developed markets would likely lead to some volatility, we view EMs as being relatively well positioned to maintain stability in an environment of gradually higher interest rates, primarily

due to healthier current account balances and more prudent fiscal positions.

Also, inflation-adjusted interest rates in some EMs remain high, giving their central banks the flexibility to lower rates if needed.

Another downturn in commodities prices could cause some selling pressure, although EMs as a whole are more broadly balanced between commodity-importing countries and commodity-exporting nations than in the past. Concerns about a sharp downturn in China have eased, but we continue to monitor the country’s transition to an economy based on domestic consumption―with a particular focus on the health of its financial system.

Overall, the future path for EM equities is likely to be less homogenous and more divergent than it was in an era when commodity prices were rising, global trade was strong, and China’s economy was growing at more than 10% annually.

This suggests that rigorous analysis of company fundamentals will be more important than ever in 2018. Being proactive will be essential to identify and invest in the most attractive opportunities within these highly diversified markets.

Active managementAny correction caused by an external event—such as a further escalation of geopolitical tension involving North Korea, political instability in developed markets politics, or protectionist trade policies in the United States—could be a potential opportunity to add to our favored positions in EM bonds. As of late 2017, we preferred local currency EM debt over U.S. dollar-denominated bonds, as some major local currencies appeared poised to gain against the U.S. dollar.

We also see select opportunities to capture value in frontier markets bonds, which tend to involve more country-specific idiosyncrasies than mainstream EMs. For example, Sri Lanka’s local currency debt currently offers some of the highest inflation-adjusted yields in the world. This, combined with the country’s improving fiscal condition and funding agreement with the International Monetary Fund, makes it attractive.

Additionally, Argentina continues to appear attractive, and we increased our overweight positions in the country’s stock and debt following the recent midterm elections that solidified support for President Macri’s reform agenda. The ability to invest in such frontier markets, which are not included in the standard EM benchmarks, is an important benefit of active portfolio management.

Active management of EM bonds also provides the ability to overweight countries, such as Brazil, that are easing monetary policy and to make country allocations based on fundamentals, as opposed to a given issuer’s amount of debt outstanding. ■

Emerging and frontier markets investments are particularly subject to market, currency, political, and economic risks, as well as the risk of abrupt and severe price declines. Bonds are subject to risks from rising interest rates, credit rating downgrades, and default.

Figure 1 Emerging Markets’ (EM) Equity ValuationsEM P/E Ratio* Rising but Still Trails World’s

*Emerging markets forward price-to-earnings ratio. Sources: FactSet and MSCI. Additional disclosures on page 24.

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14


In 1993, investors Tad Jeffrey and Rob Arnott published a milestone article asking if mutual fund investors’ additional returns over the returns of indexes were large enough to cover the taxes they incurred from these funds.* They said their research suggests that investors in taxable mutual funds investing in stocks lose approximately 2% each year to taxes.

While this may seem like a small price to pay over short time periods, it produces an enormous difference when compounded over longer periods of time (see Figure 1).

But, even as many have expanded on this research since then, there’s been little change in the day-to-day management of many taxable mutual funds to minimize taxation.

Why has this issue failed to gain much traction, particularly since a significant portion of mutual fund assets are in taxable accounts (41% at the end of 2016, according to the Investment Company Institute)? The simple reality is that most mutual fund portfolio managers are evaluated and compensated based on the pretax performance of their portfolios.

TaxesThe Internal Revenue Service (IRS) generally requires mutual funds to distribute all their income and capital gains to their shareholders each year. Investors then are responsible for paying taxes on these distributed earnings and gains, whether they received them in cash or reinvested them in additional fund shares.

Taxable distributions from mutual funds typically have come in two forms: dividends and capital gains.

ρ Dividend distributions arise from the interest and dividends earned by the underlying securities held in mutual fund portfolios. Investors must report these distributions as dividends for tax purposes, and they are generally taxed at investors’ ordinary income tax rates. Mutual funds distributed $253 billion in dividends to shareholders in 2016, according to the Investment Company Institute (ICI).

ρ Long-term capital gain distributions result from mutual funds’ net gains, if any, from the sale of securities held in their portfolios for more than one year. (Short-term capital gains—profits on a security held for less than one year—are usually taxed as dividends.) When the gains exceed losses, they are distributed to funds’ shareholders and are taxed at a maximum rate of 20%. The ICI says that mutual funds distributed $220 billion in capital gains to shareholders in 2016.

There are other tax implications for mutual funds and their shareholders. For example, some high-income investors are subject to an additional 3.8% tax on net investment income on interest, dividends, and capital gains. Investors also are liable for taxes on any capital gains resulting from the sale of their mutual fund shares, just as they would if they had sold an individual stock or bond.

Tax blind A primary reason for the large gap between pretax and after-tax returns is the level of trading activity in mutual funds. Some managers engage in high-turnover trading to maximize pretax performance, with little attention paid to the tax implications.

However, a simple reference to “turnover” is inadequate for most taxable investors. Instead, turnover should be broken down into recognition of gains and of losses. Recognizing that individual circumstance will vary, loss realization is, on the whole, good for taxable investors. Gain realization typically is a taxable event and is, therefore, bad for taxable investors.

This is because the IRS allows mutual funds to “harvest losses” by using stocks that have lost value to offset the tax liabilities produced by gains realized in other stocks. Because the IRS allows mutual fund managers to carry these losses forward to future years, this advantage holds even in a down market where there may be few, if any, gains to offset.

KEY POINTSρ Approximately 41% of mutual fund assets are held in

taxable accounts, yet the overwhelming majority of mutual funds are managed to maximize pretax returns. Research suggests that investors lose approximately 2% each year to taxes in their taxable accounts.

ρ Mutual funds are required to distribute their income and capital gains to their shareholders each year, and investors holding mutual funds in taxable accounts are responsible for paying taxes on these distributions.

ρ Tax-efficient investment management techniques—asset location, long-term focus, security selection, and using losses to offset gains—can help minimize the impact of taxes on taxable assets and maximize after-tax returns.

TA X- EFFICIENT INVESTING

Frequently Overlooked, but a Big Impact for Fund Investors—TaxesTax-efficient investing seeks to limit investors’ taxes from mutual funds’ distributed income and capital gains.

BY DONALD J. PETERS, MANAGER OF THE TAX-EFFICIENT EQUITY FUND


Figure 1 The Cost of Taxes Can Add Up Over Time$100,000 Invested for 30 Years*

*Assumes a 7% annual average return, 2% a year lost to taxes, and no new contributions. Source: T. Rowe Price.

0

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Potential Balance Lost to TaxesAfter-Tax Balance

Tax efficiencyBecause different investments and accounts receive different tax treatment from the IRS, asset location becomes a critical first step for tax-efficient investors.

Investments with high interest income, high dividends, or high turnover, such as real estate investment trusts, taxable bond funds, and high-dividend stocks, are most appropriate for tax-deferred investment accounts, such as those in 401(k) and other defined contribution plans.

The reason for this is the tax consequences arising from interest and dividend payments, as well as the frequent trading activity that takes place in most stock mutual funds.

A taxable account may be best for individual securities held for a longer time period, tax-advantaged securities, or mutual funds that take a low-turnover, growth-oriented investment approach—an approach typical of tax-efficient strategies.

A tax-efficient investment approach also calls for dramatically lower gain recognition. Our research suggests that gain-producing turnover should be held to 10% or less each year—a level not often found outside of tax-efficient investment strategies.

While most pretax-focused investors have a time horizon of 12 months or less, tax-efficient investors must invest for the long term in order to minimize the temptation to shift into and out of individual securities to chase performance or avoid losses.

The focus on long-term investments highlights the importance of security selection in a tax-efficient investment strategy.

A company’s ability to grow earnings over time is a particular point of emphasis. While dividends can result in tax liabilities for investors, the unrealized growth from price appreciation has no immediate tax consequences for a buy and hold investor.

Tax-efficient investors frequently seek companies that are early in their life cycle as these companies tend to reinvest profits into additional growth rather than pay dividends. The management teams of corporations in which tax-efficient strategies invest also should tend to be grounded in proven business concepts typical of more mature companies—that allow them to successfully evolve and compete over a full business cycle.

Tax-efficient security selection also includes tax-loss harvesting. As noted, IRS regulations allow investors to credit any losses

realized in a mutual fund portfolio against any realized short-term gains—thus harvesting losses to mitigate the tax implications of portfolio gains.

Many investors implement a form of this strategy at the end of a tax year in one major portfolio rearrangement. However, portfolio managers should spread their tax-loss selling over the course of a full year, as this gives them greater ability to monitor the market and minimize taxes.

OpportunityIt’s been almost 25 years since Mr. Jeffrey and Mr. Arnott asked if investors’ gains were large enough to cover their taxes. Unfortunately, the answer is still no.

While taxes should never be the primary focus of investment decisions or strategies, a tax-efficient investment strategy—considered carefully and implemented thoughtfully—represents an opportunity to maximize after-tax returns. ■

*Tad Jeffrey and Rob Arnott, “Is Your Alpha Big Enough to Cover Your Taxes?” The Journal of Portfolio Management, Spring 1993, pp. 15–23.

All funds are subject to market risk, including possible loss of principal. The chart is for illustrative purposes only. Past performance cannot guarantee future results.

While taxes should never be the primary focus of investment decisions or strategies, a tax-efficient investment strategy—considered carefully and implemented thoughtfully—represents an opportunity to maximize after-tax returns.

16


LAST WORD

New Survey: Parents Prioritize College but Favor Boys Over GirlsParents with only boys are more willing to save, pay, and borrow more than parents with only girls.

The ninth annual T. Rowe Price Parents, Kids & Money Survey found that parents who only have boys are going to greater lengths to support their children’s college education than parents of only girls.

The national survey, of parents of 8 to 14 year olds, found that there appears to be “a willingness to save more, pay more, and borrow more” for college expenses among parents of all boys than those of all girls, says Roger Young, a T. Rowe Price senior financial planner.

“I’m glad to see that parents of all girls seem cost-conscious about college, because price should be an important consideration,” he says. “But it’s troubling that they aren’t saving as much for their kids’ college. This suggests that there may be some antiquated expectations among parents based on gender.

“This also is somewhat ironic as more women are attending and graduating from college now than men.”

Other survey findings include that parents of all boys are more likely than parents of all girls (see Figure 1):

ρ To have saved money for college (50% vs. 39%).

ρ To say they will cover the entire cost of college (17% vs. 8%).

ρ To take on significant debt for college (23% vs. 12%) or let their kids take on significant student debt (29% vs. 17%).

ρ To prioritize college savings over retirement savings (68% vs. 50%).

Scaling back retirementAs in prior such surveys by the firm, parents in this one reported that they are willing to scale back their retirement saving in order to cover their children’s college education expenses.

More parents are saving for their kids’ college than their own retirement (53% vs. 49%), and many (73%) are willing to delay their retirement to pay college costs. (Dads of all boys are particularly likely to say that saving for their kids’ college is a priority over saving for retirement, even when compared with moms of all boys.)

Moreover, more parents have pulled money from their retirement savings for their children’s education in recent years than from their college savings (44% vs. 32%). The primary reason for these withdrawals was to pay off debt, but college expenses came in second.

“It’s a difficult balancing act to fully fund retirement and save for kids’ college

education,” Mr. Young says. “Parents will always go to great lengths to provide for their kids, but they should be cautious about prioritizing college over retirement.

“College degrees come with a variety of price tags, and there are multiple ways to pay for a degree. But nearly everyone could benefit from supplementing Social Security with personal savings in order to ensure a comfortable retirement.” ■

The ninth annual T. Rowe Price Parents, Kids & Money Survey, conducted by Research Now, aimed to understand the basic financial knowledge, attitudes, and behaviors of both parents of kids ages 8 to 14 and their kids ages 8 to 14. The survey was fielded from January 18, 2017, through January 26, 2017, with a sample size of 1,014 parents and 1,014 kids ages 8 to 14. The margin of error is +/- 3.1 percentage points. All statistical testing done among subgroups (e.g., boys versus girls) is conducted at the 90% or 95% confidence level, depending on sample sizes. Reporting includes only findings that are statistically significant at these levels.

Parents of only boys are more likely to have money saved for college.

More boys say that their parents are saving for their college.

There is a greater willingness among parents of only boys to take on $75,000 or more in student loans.

Parents of only boys are less likely to consider a lower-cost college compared with parents of only girls.

50%

23%

60%

65%

39%

12%

72%

53%

BOYS GIRLS

Source: T. Rowe Price Parents, Kids & Money Survey 2017.

Figure 1 Parents’ College Saving Habits and Attitudes Boys Decidedly Favored Over Girls


PERFORMANCE SUMMARY PAST QUARTER, YEAR, AND AVERAGE ANNUAL TOTAL RETURNS PERIODS ENDED DECEMBER 31, 2017

Quarterly Performance UpdateT. Rowe Price

Global Growth, U.S. Tax Reform Drive Year-End Rally

KEY POINTS ρ Most major U.S. equity indexes closed the year near record highs.

ρ Economic data and merger news supported sentiment.

ρ Fed rate increase in mid-December was widely expected and not disruptive.

EQUIT Y REVIEWEmerging markets lead; large-cap and growth stocks outperformed in the U.S.

All Wilshire 5000 sectors produced positive returns. Consumer discretionary stocks performed best. Information technology shares also produced excellent returns, adding to earlier gains and surpassing all other sectors for the year. Real estate, telecommunication services, and health care stocks lagged the broad market. Utilities stocks were nearly flat.

Developed Asian markets performed very well in dollar terms. Eurozone markets lagged with milder gains. Although eurozone economies continued to expand, investor sentiment was hurt somewhat by some disappointing corporate earnings reports and political uncertainty in a few countries. Shares climbed nearly 6% in the UK, which reached an agreement with the European Union on a so-called Brexit-related “divorce bill.”

Most emerging Asian markets performed well, led by India, South Korea, and Thailand. Emerging European markets posted good returns. In Latin America, the smaller markets advanced, but Brazilian shares fell 2%, while Mexican stocks dropped 8%.

-5 0 5 10 15 20 25 30 35 40%

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Industrials and Business Services

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Telecommunication Services

Health Care

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22.185.42-2.452.979.201.99-1.471.34

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12.69

■ 3 Months ■ 1 Year

Ranked by highest to lowest quarterly returns.

Figure 1 U.S. and International Stock Market PerformanceTotal Returns for Periods Ended December 31, 2017

Figure 2 Performance of Wilshire 5000 SeriesTotal Returns for Periods Ended December 31, 2017

December 31, 2017

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Figure 3 U.S. and International Bond Market PerformanceTotal Returns for Periods Ended December 31, 2017

FIXED INCOME REVIEWGlobal bond returns were mostly positive; some emerging markets currencies moved sharply

Domestic bonds produced flat to slightly positive returns. Short-term Treasury yields rose in anticipation of Fed rate increases, but longer-term yields rose to a lesser extent or decreased.

In the investment-grade universe, long-term corporate bonds fared best. Mortgage- and asset-backed securities were little changed. Tax-free municipal bonds outperformed their taxable bond peers. High yield issues marginally outperformed higher-quality securities.

Bonds in developed non-U.S. markets did well in dollar terms, as yields eased in several eurozone markets and the euro gained 1.5% versus the dollar. In the UK, where the Bank of England raised short-term rates in November, government bond yields declined amid hopes that inflation is nearing a peak. The Japanese yen and 10-year government bond yield were little changed.

Emerging markets bond returns were mostly positive. However, Mexican bond prices declined as interest rates rose and the peso fell 7%. Also, the Brazilian real and the Turkish lira declined moderately, reducing their local bond returns in dollar terms.

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Figure 4 Trends in Interest RatesAs of December 31, 2017

Unlike stocks, U.S. government bonds are guaranteed as to the timely payment of interest and principal.

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6.64 6.25 6.273.34 4.27

0.39 0.75 0.54

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Figure 5 Stock and Bond Market PerformanceTotal Returns for Periods Ended December 31, 2017



DomesticTicker symbol 3 months 1 year 3 years 5 years

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Expense ratio

Expense ratio as of date

Blue Chip Growth TRBCX 7.00% 36.55% 15.30% 18.85% 10.50% 6/30/93 0.72% 12/31/16Capital Appreciation2 PRWCX 2.95 15.38 9.59 12.59 9.00 6/30/86 0.70 12/31/16Capital Opportunity PRCOX 6.52 23.72 11.96 15.89 8.61 11/30/94 0.70 12/31/16Diversified Mid-Cap Growth PRDMX 5.89 24.72 11.02 15.47 9.21 12/31/03 0.87 12/31/16Dividend Growth PRDGX 5.83 19.32 10.88 14.83 8.51 12/30/92 0.64 12/31/16Equity Income PRFDX 5.44 16.18 8.96 12.52 6.91 10/31/85 0.66 12/31/16Equity Index 500 PREIX 6.60 21.55 11.14 15.50 8.25 3/30/90 0.5% 90 days 0.23 8/1/17Extended Equity Market Index PEXMX 4.59 17.96 9.77 14.52 9.24 1/30/98 0.5 90 days 0.35 12/31/16Financial Services PRISX 5.05 19.09 11.42 15.99 7.02 9/30/96 0.93 12/31/16Growth & Income PRGIX 6.16 21.05 10.56 15.19 8.17 12/21/82 0.67 12/31/16Growth Stock PRGFX 6.05 33.63 14.53 17.88 9.99 4/11/50 0.68 12/31/16Health Sciences PRHSX 1.66 27.95 9.03 20.95 15.30 12/29/95 0.77 12/31/16Media & Telecommunications PRMTX 4.99 32.99 16.99 18.61 12.66 10/13/93 0.79 12/31/16Mid-Cap Growth2 RPMGX 4.43 24.86 12.25 16.98 10.72 6/30/92 0.77 12/31/16Mid-Cap Value2 TRMCX 5.16 11.64 10.26 14.29 9.52 6/28/96 0.80 12/31/16New America Growth PRWAX 7.10 34.57 14.08 17.48 10.77 9/30/85 0.80 12/31/16New Era PRNEX 6.62 10.58 3.94 3.67 -0.49 1/20/69 0.67 12/31/16New Horizons2 PRNHX 4.63 31.49 13.99 18.57 13.16 6/3/60 0.79 12/31/16QM U.S. Small-Cap Growth Equity PRDSX 5.90 22.12 11.63 16.37 11.39 6/30/97 1.0 90 days 0.81 12/31/16QM U.S. Small & Mid-Cap Core Equity TQSMX 5.66 15.93 --- --- 22.50 2/26/16 1.0 90 days 2.61† 12/31/16QM U.S. Value Equity TQMVX 6.67 15.91 --- --- 21.35 2/26/16 3.63† 12/31/16Real Assets PRAFX 5.47 10.47 4.48 2.71 4.05 7/28/10 2.0 90 days 0.84 12/31/16Real Estate TRREX 3.28 4.42 5.07 9.22 7.36 10/31/97 1.0 90 days 0.74 12/31/16Science & Technology PRSCX 7.63 39.22 19.13 22.29 12.24 9/30/87 0.83 12/31/16Small-Cap Stock2 OTCFX 3.44 15.27 9.79 14.26 10.88 6/1/56 0.90 12/31/16Small-Cap Value PRSVX 3.30 13.37 11.69 13.12 9.42 6/30/88 1.0 90 days 0.93 12/31/16Tax-Efficient Equity3 PREFX 12/29/00 1.0 365 days 0.83 2/28/17Returns before taxes 6.34 29.13 12.04 15.87 8.78Returns after taxes on distributions --- 28.20 11.70 15.30 8.51Returns after taxes on distributions and sale of fund shares --- 17.24 9.39 12.73 7.16

Total Equity Market Index POMIX 6.22 20.80 10.95 15.44 8.53 1/30/98 0.5 90 days 0.30 12/31/16U.S. Large-Cap Core TRULX 6.16 20.93 11.91 15.62 15.29 6/26/09 0.81† 12/31/16Value TRVLX 6.02 18.94 9.05 15.08 8.52 9/30/94 0.82 12/31/16

Figure 6 Stock Funds

The performance information presented here includes changes in principal value, reinvested dividends, and capital gain distributions. Current performance may be higher or lower than the quoted past performance, which cannot guarantee future results. Share price, principal value, yield, and return will vary, and you may have a gain or loss when you sell your shares. To obtain the most recent month-end performance, call us at 1-800-225-5132 or visit our website. The performance information shown does not reflect the deduction of redemption fees (if applicable); if it did, the performance would be lower. Call 1-800-225-5132 to request a prospectus or summary prospectus; each includes investment objectives, risks, fees, expenses, and other information that you should read and consider carefully before investing. Funds are placed in alphabetical order in each category. To learn more about each fund’s objective and risk/reward potential, visit troweprice.com/mutualfunds.

† This fund currently operates under a contractual expense limitation that may be lower than the expense ratio shown in the table above; for information about the expense limitation, including its expiration date, please see the fund’s prospectus.

1 If a fund has less than 10 years of performance history, its since-inception return is shown.2 Closed to new investors except for a direct rollover from a retirement plan into a T. Rowe Price IRA invested in this fund.3 The returns presented reflect the return before taxes; the return after taxes on dividends and capital gain distributions; and the return after taxes on dividends, capital gain distributions, and gains (or losses) from redemptions of shares held for 1-, 5-, and 10-year periods, as applicable. After-tax returns reflect the highest federal income tax rate but exclude state and local taxes. The after-tax returns reflect the rates applicable to ordinary and qualified dividends and capital gains effective in 2003. During periods when a fund incurs a loss, the post-liquidation after-tax return may exceed the fund’s other returns because the loss generates a tax benefit that is factored into the result. An investor’s actual after-tax return will likely differ from those shown and depend on his or her tax situation. Past before- and after-tax returns do not necessarily indicate future performance.

https://www3.troweprice.com/usis/personal-investing/mutual-funds.html?van=mutualfunds

20

PAST QUARTER, YEAR, AND AVERAGE ANNUAL TOTAL RETURNS PERIODS ENDED DECEMBER 31, 2017 PERFORMANCE SUMMARY

International/GlobalTicker symbol 3 months 1 year 3 years 5 years

10 years or since

inception1Inception

dateRedemption


Expense ratio


Africa & Middle East TRAMX 11.24% 23.64% 1.93% 7.50% -0.36% 9/4/07 2.0% 90 days 1.56% 10/31/16Asia Opportunities TRAOX 8.36 43.23 14.21 --- 12.82 5/21/14 2.0 90 days 2.10† 10/31/16Emerging Europe TREMX 2.35 19.73 9.37 -2.67 -6.14 8/31/00 2.0 90 days 1.75 10/31/16Emerging Markets Stock PRMSX 7.39 42.85 12.27 6.47 1.46 3/31/95 2.0 90 days 1.26 10/31/16Emerging Markets Value Stock PRIJX 5.36 34.12 --- --- 18.82 9/14/15 2.0 90 days 3.21† 10/31/16European Stock PRESX 1.21 25.72 4.23 7.61 2.94 2/28/90 2.0 90 days 0.96 10/31/16Global Consumer PGLOX 6.00 20.81 --- --- 14.57 6/27/16 4.14 12/31/16Global Growth Stock RPGEX 6.37 34.26 11.73 12.67 16.68 10/27/08 2.0 90 days 1.19† 10/31/16Global Industrials RPGIX 4.11 25.92 10.90 --- 8.36 10/24/13 2.29† 12/31/16Global Real Estate TRGRX 4.25 7.60 3.98 5.46 12.04 10/27/08 2.0 90 days 0.99† 12/31/16Global Stock PRGSX 7.60 33.09 14.75 16.34 5.17 12/29/95 2.0 90 days 0.89 10/31/16Global Technology2 PRGTX 6.22 47.04 23.82 26.92 16.94 9/29/00 0.90 12/31/16International Concentrated Equity PRCNX 1.38 21.06 8.26 --- 4.72 8/22/14 2.0 90 days 3.27† 10/31/16International Discovery PRIDX 6.06 39.01 15.53 13.81 6.86 12/30/88 2.0 90 days 1.20 10/31/16International Equity Index PIEQX 4.23 26.45 8.38 7.53 2.01 11/30/00 2.0 90 days 0.45 10/31/16International Stock PRITX 3.53 28.18 9.17 8.08 3.35 5/9/80 2.0 90 days 0.84 10/31/16International Value Equity4 TRIGX 1.39 20.79 5.59 6.51 1.44 12/21/98 2.0 90 days 0.85 10/31/16Japan PRJPX 8.16 32.66 19.23 15.04 4.90 12/30/91 2.0 90 days 1.02 10/31/16Latin America PRLAX -2.26 29.70 7.31 -2.02 -1.75 12/29/93 2.0 90 days 1.38 10/31/16New Asia PRASX 8.01 41.33 10.62 7.56 4.06 9/28/90 2.0 90 days 0.95 10/31/16Overseas Stock TROSX 3.05 27.02 8.40 8.17 2.74 12/29/06 2.0 90 days 0.84 10/31/16QM Global Equity TQGEX 5.31 24.91 --- --- 16.95 4/15/16 2.0 90 days 3.58 12/31/16

International/Global Stock 3 months 1 year 3 years 5 years 10 years

MSCI EAFE Index 4.27% 25.62% 8.30% 8.39% 2.42%Lipper AveragesEmerging Markets Funds 6.26 34.57 7.98 4.26 1.49International Large-Cap Core Funds 3.93 25.00 6.90 6.74 1.81International Large-Cap Growth Funds 3.99 27.28 7.56 6.95 2.36International Small/Mid-Cap Growth Funds 5.73 34.37 11.98 11.05 4.94

Figure 8 Stock Funds

Figure 9 Benchmarks

Domestic Stock 3 months 1 year 3 years 5 years 10 years

S&P 500 Index 6.64% 21.83% 11.41% 15.79% 8.50%S&P MidCap 400 Index 6.25 16.24 11.14 15.01 9.97NASDAQ Composite Index (Principal Return) 6.27 28.24 13.38 17.98 10.04Russell 2000 Index 3.34 14.65 9.96 14.12 8.71Lipper IndexesLarge-Cap Core Funds 6.93 21.63 10.70 14.76 7.65Equity Income Funds 5.51 16.43 8.91 12.98 6.96Small-Cap Core Funds 4.18 13.95 10.17 13.64 8.69

Figure 7 Benchmarks

4Formerly the T. Rowe Price International Growth & Income Fund.All mutual funds are subject to market risk, including possible loss of principal. Funds that invest overseas generally carry more risk than funds that invest strictly in U.S. assets due to factors such as currency risk, geographic risk, and emerging markets risk. Funds that invest in fixed income securities are subject to credit risk and liquidity risk, with high yield securities having a greater risk of default than higher-quality securities. Such funds are also subject to the risk that a rise in interest rates will cause the price of a fixed rate debt security to fall. During periods of extremely low or negative interest rates, some funds may not be able to maintain a positive yield.MSCI index returns are shown with gross dividends reinvested.



Domestic TaxableTicker symbol 3 months 1 year 3 years 5 years

10 years or since

inception1Inception

dateRedemption


Expense ratio


Corporate Income PRPIX 1.02% 6.57% 3.62% 3.49% 5.52% 10/31/95 0.60% 5/31/17Credit Opportunities PRCPX 0.58 6.78 5.06 --- 2.19 4/29/14 2.0% 90 days 1.50† 5/31/17Floating Rate PRFRX 0.99 3.47 4.08 3.56 3.82 7/29/11 2.0 90 days 0.77† 5/31/17GNMA6 PRGMX -0.32 1.22 1.26 1.33 3.41 11/26/85 0.59 5/31/17High Yield2 PRHYX 0.77 7.37 5.96 5.76 7.32 12/31/84 2.0 90 days 0.74 5/31/17Inflation Protected Bond PRIPX 1.28 2.75 1.56 -0.23 3.10 10/31/02 0.58† 5/31/17Limited Duration Inflation Focused Bond TRBFX 0.20 0.80 0.84 -0.05 1.50 9/29/06 0.50† 5/31/17New Income PRCIX 0.48 4.01 2.26 2.02 4.26 8/31/73 0.55 5/31/17Short-Term Bond PRWBX -0.19 1.33 1.17 0.88 2.18 3/2/84 0.46 5/31/17Total Return PTTFX 0.66 5.01 --- --- 4.07 11/15/16 1.72† 5/31/17Ultra Short-Term Bond TRBUX 0.44 1.83 1.41 0.96 0.95 12/3/12 0.44† 5/31/17U.S. Bond Enhanced Index PBDIX 0.41 3.82 2.26 2.11 4.06 11/30/00 0.5 90 days 0.30 10/31/16U.S. High Yield7 TUHYX 0.86 --- --- --- 3.89 5/19/17 2.0 90 days 4.68† 5/31/17U.S. Treasury Intermediate6 PRTIX -0.65 1.38 1.03 0.63 3.49 9/29/89 0.52 5/31/17U.S. Treasury Long-Term6 PRULX 2.32 8.22 2.26 2.78 6.15 9/29/89 0.51 5/31/17

Figure 11 Bond Funds

Domestic Tax-Free5Ticker symbol 3 months 1 year 3 years 5 years

10 years or since

inception1Inception

dateRedemption


Expense ratio


California Tax-Free Bond PRXCX 0.86% 5.53% 3.12% 3.51% 4.66% 9/15/86 0.50% 2/28/17Georgia Tax-Free Bond GTFBX 0.90 4.72 2.69 2.86 4.13 3/31/93 0.52 2/28/17Intermediate Tax-Free High Yield PRIHX 0.88 6.00 3.39 --- 3.82 7/24/14 2.0% 90 days 1.09† 2/28/17Maryland Short-Term Tax-Free Bond PRMDX -0.53 1.09 0.44 0.54 1.26 1/29/93 0.55 2/28/17Maryland Tax-Free Bond MDXBX 1.11 4.90 2.99 3.04 4.44 3/31/87 0.46 2/28/17New Jersey Tax-Free Bond NJTFX 1.13 5.29 2.99 3.12 4.35 4/30/91 0.52 2/28/17New York Tax-Free Bond PRNYX 0.45 4.68 2.90 2.95 4.25 8/28/86 0.51 2/28/17Summit Municipal Income PRINX 1.13 5.93 3.25 3.40 4.85 10/29/93 0.50 10/31/16Summit Municipal Intermediate PRSMX 0.18 4.19 2.31 2.53 3.96 10/29/93 0.50 10/31/16Tax-Free High Yield PRFHX 1.51 7.30 4.15 4.40 5.31 3/1/85 2.0 90 days 0.69 2/28/17Tax-Free Income PRTAX 0.90 5.15 2.85 3.04 4.46 10/26/76 0.52 2/28/17Tax-Free Short-Intermediate PRFSX -0.56 1.74 0.83 0.98 2.38 12/23/83 0.49 2/28/17Virginia Tax-Free Bond PRVAX 1.05 4.71 2.91 2.93 4.32 4/30/91 0.47 2/28/17


Bond 3 months 1 year 3 years 5 years 10 years

Bloomberg Barclays U.S. Aggregate Bond Index 0.39% 3.54% 2.24% 2.10% 4.01%Bloomberg Barclays Municipal Bond Index 0.75 5.45 2.98 3.02 4.46Credit Suisse High Yield Index 0.54 7.03 6.42 5.72 7.61Lipper AveragesShort Investment Grade Debt Funds 0.01 1.68 1.35 1.04 2.04Core Bond Funds 0.33 3.56 2.15 1.95 3.83GNMA Funds -0.25 1.05 0.92 1.03 3.42High Yield Funds 0.48 6.58 5.00 4.63 6.42Short Municipal Debt Funds -0.29 1.32 0.52 0.56 1.37Intermediate Municipal Debt Funds 0.30 4.31 2.09 2.05 3.46General & Insured Municipal Debt Funds 0.87 5.41 2.81 2.80 4.04

Figure 12 Benchmarks

5 Some income from the tax-free funds may be subject to state and local taxes and the federal alternative minimum tax.6 The market value of shares is not guaranteed by the U.S. government.7 The T. Rowe Price U.S. High Yield Fund (“Fund”) commenced operations on May 19, 2017. At that time, the Fund received all of the assets and liabilities of the Henderson High Yield Opportuni-ties Fund (the “Predecessor Fund”) and adopted its performance and accounting history. The Fund and the Predecessor Fund have substantially similar investment objectives and strategies. The Predecessor Fund was managed by the same portfolio manager as the Fund.

22

PAST QUARTER, YEAR, AND AVERAGE ANNUAL TOTAL RETURNS PERIODS ENDED DECEMBER 31, 2017 PERFORMANCE SUMMARY


International/GlobalTicker symbol 3 months 1 year 3 years 5 years

10 years or since

inception1Inception

dateRedemption


Expense ratio


Dynamic Global Bond8 RPIEX -0.72% -1.90% --- --- 2.26% 1/22/15 1.16% 12/31/16Emerging Markets Bond PREMX -0.34 8.98 7.92% 3.79% 6.49 12/30/94 2.0% 90 days 0.92† 12/31/16Emerging Markets Corporate Bond TRECX 0.74 8.87 6.36 4.05 5.75 5/24/12 2.0 90 days 1.36† 12/31/16Emerging Markets Local Currency Bond PRELX 0.41 15.76 2.67 -1.74 -0.19 5/26/11 2.0 90 days 1.04† 12/31/16

Global High Income Bond9 RPIHX 0.99 8.68 --- --- 7.72 1/22/15 2.0 90 days 1.51 12/31/16Global Multi-Sector Bond PRSNX 0.67 6.46 4.37 3.53 6.96 12/15/08 0.81† 5/31/17International Bond RPIBX 1.73 11.15 2.32 -0.17 2.28 9/10/86 2.0 90 days 0.69 8/1/17International Bond (USD Hedged) TNIBX 1.52 --- --- --- 1.24 9/12/17 2.0 90 days 1.96† 9/12/17

International/Global Bond 3 months 1 year 3 years 5 years 10 years

Bloomberg Barclays Global Aggregate ex USD Bond Index 1.63% 10.51% 1.77% -0.20% 2.40%

J.P. Morgan Emerging Markets Bond Index Global 0.54 9.32 6.84 3.75 7.06Lipper AveragesEmerging Market Hard Currency Debt Funds 0.74 10.68 5.83 2.39 6.23International Income Funds 0.67 7.86 1.94 0.82 3.83

Figure 14 Benchmarks

Figure 15 Money Market Funds

Tax-Free10Ticker symbol

7-day yield

7-dayunsubsidized

yield10 3 months 1 year 3 years 5 years

10 years or since

inception1Inception

dateExpense

ratio


California Tax-Free Money◊ PCTXX 0.73% 0.73% 0.11% 0.29% 0.12% 0.07% 0.22% 9/15/86 0.88%† 2/28/17Maryland Tax-Free Money◊ TMDXX 0.95 0.95 0.13 0.31 0.11 0.07 0.23 3/30/01 0.67 2/28/17New York Tax-Free Money◊ NYTXX 0.85 0.85 0.12 0.30 0.12 0.07 0.23 8/28/86 0.84† 2/28/17Summit Municipal Money Market◊ TRSXX 0.94 0.94 0.16 0.44 0.18 0.11 0.28 10/29/93 0.45 10/31/16Tax-Exempt Money◊ PTEXX 0.99 0.99 0.19 0.46 0.18 0.11 0.27 4/8/81 0.54 2/28/17Taxable10

Cash Reserves‡11 TSCXX 1.10 1.10 0.23 0.72 0.28 0.17 0.39 10/29/93 0.45% 10/31/16Government Money‡* PRRXX 0.90 0.90 0.19 0.51 0.18 0.11 0.33 1/26/76 0.44 5/31/17U.S. Treasury Money‡ PRTXX 0.85 0.85 0.18 0.49 0.17 0.11 0.21 6/28/82 0.42 5/31/17

8 Formerly the T. Rowe Price Global Unconstrained Bond Fund.9 Formerly the T. Rowe Price Strategic Income Fund.*Formerly the T. Rowe Price Prime Reserve Fund.

Money Market Funds:◊ Retail Funds: You could lose money by investing in the Fund. Although the Fund seeks to preserve the value of your investment at $1.00 per share, it cannot guarantee it will do so. Beginning October 14, 2016, the Fund may impose a fee upon the sale of your shares or may temporarily suspend your ability to sell shares if the Fund’s liquidity falls below required minimums because of market conditions or other factors. An investment in the Fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. The Fund’s sponsor has no legal obligation to provide financial support to the Fund, and you should not expect that the sponsor will provide financial support to the Fund at any time.

‡ Government Funds: You could lose money by investing in the Fund. Although the Fund seeks to preserve the value of your investment at $1.00 per share, it cannot guarantee it will do so. An investment in the Fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. The Fund’s sponsor has no legal obligation to provide financial support to the Fund, and you should not expect that the sponsor will provide financial support to the Fund at any time.

10 In an effort to maintain a zero or positive net yield for the fund, T. Rowe Price may voluntarily waive all or a portion of the management fee it is entitled to receive from the fund. This voluntary waiver would be in addition to any contractual expense ratio limitation in effect for the fund and may be amended or terminated at any time without prior notice. This fee waiver would have the effect of increasing the fund’s 7-day yield. Please see the prospectus for more details.

11 Formerly the T. Rowe Price Summit Cash Reserves Fund.



Asset AllocationTicker symbol 3 months 1 year 3 years 5 years

10 years or since

inception1Inception

dateRedemption


Expense ratio


Balanced RPBAX 3.62% 18.01% 7.95% 9.71% 6.56% 12/31/39 0.68% 12/31/16Global Allocation RPGAX 3.08 17.02 7.50 --- 7.25 5/28/13 1.24† 10/31/16Personal Strategy Balanced TRPBX 3.38 17.31 7.89 9.37 6.75 7/29/94 0.87 5/31/17Personal Strategy Growth TRSGX 4.31 21.91 9.39 11.60 7.06 7/29/94 0.88 5/31/17Personal Strategy Income PRSIX 2.36 12.79 6.23 7.00 5.91 7/29/94 0.75 5/31/17Retirement 2005 TRRFX 2.17 10.67 5.44 6.14 5.09 2/27/04 0.58 5/31/17Retirement 2010 TRRAX 2.34 11.66 5.88 6.88 5.24 9/30/02 0.57 5/31/17Retirement 2015 TRRGX 2.70 13.34 6.54 7.97 5.67 2/27/04 0.59 5/31/17Retirement 2020 TRRBX 3.11 15.74 7.41 9.09 6.04 9/30/02 0.63 5/31/17Retirement 2025 TRRHX 3.47 17.68 8.11 10.06 6.34 2/27/04 0.67 5/31/17Retirement 2030 TRRCX 3.83 19.45 8.75 10.92 6.63 9/30/02 0.69 5/31/17Retirement 2035 TRRJX 4.07 20.88 9.22 11.53 6.83 2/27/04 0.72 5/31/17Retirement 2040 TRRDX 4.31 22.02 9.57 11.96 7.06 9/30/02 0.74 5/31/17Retirement 2045 TRRKX 4.37 22.41 9.71 12.03 7.10 5/31/05 0.74 5/31/17Retirement 2050 TRRMX 4.42 22.38 9.71 12.04 7.10 12/29/06 0.74 5/31/17Retirement 2055 TRRNX 4.41 22.33 9.70 12.02 7.08 12/29/06 0.74 5/31/17Retirement 2060 TRRLX 4.38 22.29 9.68 --- 8.27 6/23/14 0.74 5/31/17Retirement Balanced TRRIX 2.16 10.36 5.26 5.76 4.94 9/30/02 0.56 5/31/17Retirement Income 2020 TRLAX 3.02 --- --- --- 6.88 5/25/17 1.31 5/25/17Spectrum Growth PRSGX 4.99 25.52 10.89 13.11 7.34 6/29/90 0.80 12/31/16Spectrum Income RPSIX 1.08 7.02 4.29 3.95 5.23 6/29/90 0.69 12/31/16Spectrum International PSILX 3.81 28.54 8.36 7.83 3.09 12/31/96 2.0% 90 days 0.94 12/31/16Target 2005 TRARX 1.87 9.84 5.14 --- 5.70 8/20/13 1.35 5/31/17Target 2010 TRROX 2.02 10.25 5.26 --- 5.91 8/20/13 0.92 5/31/17Target 2015 TRRTX 2.20 11.00 5.57 --- 6.32 8/20/13 0.67 5/31/17Target 2020 TRRUX 2.48 12.63 6.14 --- 7.01 8/20/13 0.69 5/31/17Target 2025 TRRVX 2.76 14.34 6.79 --- 7.78 8/20/13 0.77 5/31/17Target 2030 TRRWX 3.17 16.21 7.55 --- 8.63 8/20/13 0.83 5/31/17Target 2035 RPGRX 3.44 17.90 8.14 --- 9.34 8/20/13 0.98 5/31/17Target 2040 TRHRX 3.76 19.42 8.69 --- 9.89 8/20/13 1.06 5/31/17Target 2045 RPTFX 3.90 20.38 9.04 --- 10.28 8/20/13 1.23 5/31/17Target 2050 TRFOX 4.19 21.42 9.34 --- 10.63 8/20/13 1.55 5/31/17Target 2055 TRFFX 4.28 22.04 9.58 --- 10.84 8/20/13 2.17 5/31/17Target 2060 TRTFX 4.39 22.23 9.64 --- 8.21 6/23/14 5.40 5/31/17

Figure 16 Asset Allocation Funds

Indexes included in this update track the following: S&P 500—500 large-company U.S. stocks; S&P MidCap 400—stocks of 400 mid-size U.S. companies; NASDAQ Composite (principal only)—U.S. stocks traded in the over-the-counter market; Russell 2000—stocks of 2,000 small U.S. companies; MSCI EAFE—stocks of about 1,000 companies in Europe, Australasia, and the Far East; MSCI Emerging Markets—more than 850 stocks traded in over 20 emerging markets; Bloomberg Barclays U.S. Aggregate Bond—investment-grade corporate and government bonds; Bloomberg Barclays Municipal Bond—tax-free investment-grade U.S. bonds; Credit Suisse High Yield—noninvestment-grade corporate U.S. bonds; Bloomberg Barclays Global Aggregate ex USD Bond—investment-grade government, corporate, agency, and mortgage-related bonds in markets outside the U.S.; J.P. Morgan Emerging Markets Bond–Global—U.S. dollar-denominated Brady Bonds, Eurobonds, traded loans, and local market debt instruments issued by sovereign and quasi-sovereign entities; Lipper averages—all funds in each investment objective category; and Lipper indexes—equally weighted indexes of typically the 30 largest mutual funds within their respective investment objective categories. It is not possible to invest directly in an index.

24

Editor: Robert BenjaminWriters: John Dixon, Ralph Johnston, Nick

Loney, Bill Montague, Steven E. Norwitz, and Aaron Rowlands

Editor Emeritus: Steven E. Norwitz

Charts and examples in this issue showing investment performance (excluding those in the Performance Update section) are for illustrative purposes only and do not reflect the performance of any T. Rowe Price fund or security. A manager’s view of the attractiveness of a company may change, and the fund could sell the holding at any time. This material should not be deemed a recommendation to buy or sell shares of any of the securities discussed. Past performance cannot guarantee future results.T. Rowe Price, Invest With Confidence, and the bighorn sheep design are trademarks or registered trademarks of T. Rowe Price Group, Inc., in the United States and other countries.T. Rowe Price Investment Services, Inc., Distributor.© 2018 T. Rowe Price All Rights Reserved.04779_UD 201801-441188M00-066 1/18

Additional DisclosureSource: BofA Merrill Lynch, used with permission. BofA Merrill Lynch is licensing the BofA Merrill Lynch indices “as is;” makes no warranties regarding same; does not guarantee the suitability, quality, accuracy, timeliness, and/or completeness of the BofA Merrill Lynch indices or any data included in, related to, or derived there from; assumes no liability in connection with their use; and does not sponsor, endorse, or recommend T. Rowe Price or any of its products or services.

Bloomberg Index Services Ltd. Copyright 2017, Bloomberg Index Services Ltd. Used with permission.

Information has been obtained from sources believed to be reliable, but J.P. Morgan does not warrant its completeness or accuracy. The index is used with permission. The index may not be copied, used, or distributed without J.P. Morgan’s prior written approval. Copyright © 2017, J.P. Morgan Chase & Co. All rights reserved.

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.

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T. Rowe Price REPORT · The valuation multiples currently awarded to some of these stocks appear...

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Transcript of T. Rowe Price REPORT · The valuation multiples currently awarded to some of these stocks appear...