t. rowe price 2013 investment & economic outlook

PRESS BRIEFING

Copyright 2012. T. Rowe Price. All Rights Reserved.

T. Rowe Price 2013 Investment & Economic Outlook

2013 INVESTMENT & ECONOMIC OUTLOOK | Press Briefing


Welcome and Introductory RemarksEdward GiltenanDirector of Public Relations

U.S. Stocks Make Five-Year Round Trip

S&P 500 cut in half by market bottom (March 2009)...…only to recover by about 130%.

Source: T. Rowe Price

0

500

1,000

1,500

2,000

9/07 9/08 9/09 9/10 9/11 9/12

S&

P 5

00

S&P 500 LevelsPrincipal Value

September 30, 2007 - September 30, 2012

Diversification Helps Weather Tough Five-Year Period

−A balanced portfolio, boosted by exposure to bonds, performed relatively well.−Stocks lagged, but there have been far worse periods. Since the Great

Depression, there have been six 5-year periods (measured on a rolling calendar year basis) in which stocks lost 10% or more.

Total Return for Stocks, Bonds, and a Balanced PortfolioSeptember 30, 2007 - September 30, 2012

25

50

75

100

125

150

9/07 9/08 9/09 9/10 9/11 9/12

Tota

l Ret

urn

Inde

xed

to 1

00 a

t 9/3

0/07

IA SBBI S&P 500 Total Return U.S.$ (Index)Barclays U.S. Aggregate Bond Total Return U.S.$ (Index)

60% S&P 500, 40% Barclays U.S. Aggregate Bond (Index)

137.20*

119.76*

105.37*

*Returns are cumulative,Sources: Ned Davis Research, T. Rowe Price

T. Rowe Price Retirement 2010 Fund Performance Since Inception

Cumulative Growth of $100,000September 30, 2002 (Fund Inception) – September 30, 2012

100,000

130,000

160,000

190,000

220,000

250,000

9/02

12/0

23/

036/

039/

0312

/03

3/04

6/04

9/04

12/0

43/

056/

059/

0512

/05

3/06

6/06

9/06

12/0

63/

076/

079/

0712

/07

3/08

6/08

9/08

12/0

83/

096/

099/

0912

/09

3/10

6/10

9/10

12/1

03/

116/

119/

1112

/11

3/12

6/12

9/12

U.S

.$

Retirement 2010 Fund

Despite a steep loss in 2007-2009 bear market……the fund returned an annualized 8.2% over the “Lost Decade.”

T. Rowe Price Retirement 2010 Fund’s average annual total returns were 17.98%, 3.12%, 9.26%, and 8.20% for the 1-, 3- 5-, and 10-year periods, respectively, as of September 30, 2012. Current performance may be higher or lower than the quoted past performance, which cannot guarantee future results. Share price, principal value, 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, please call 1-800-638-5660 or go to troweprice.com. The fund's expense ratio was 0.61% as of its fiscal year ended 5/31/2012. Figures include changes in principal value, reinvested dividends, and capital gain distributions.

Retirement Account Performance Before and After the Crisis

050,000

100,000150,000200,000250,000300,000350,000400,000450,000500,000550,000600,000650,000

5/07

8/07

11/0

7

2/08

5/08

8/08

11/0

8

2/09

5/09

8/09

11/0

9

2/10

5/10

8/10

11/1

0

2/11

5/11

8/11

11/1

1

2/12

5/12

8/12

U.S

.$

Account Value

Portfolio drops to $301,000 in value in March 2009.But rebounds to $440,000 by September 2012…

…even after retiree draws $120,000 in total income.*Assumes the annual withdrawal increases each year by the percent change in the Consumer Price Index for All Urban Consumers (CPI-U), not seasonally adjusted (if greater than 0%) or by 0% (if annual % change of CPI-U is negative).This example is shown for illustrative purposes only. Results will vary. Past performance cannot guarantee future results.

T. Rowe Price Investment Services, Inc, distributor

T. Rowe Price Retirement Date Fund 2010 Portfolio Monthly Account Value

Assumes 4% Initial Withdrawal Rate with Annual Inflation Adjustments*Starting May 31, 2007 - September 30, 2012

Disclosure

The principal value of the Retirement Funds is not guaranteed at any time, including at or after the target date, which is the approximate date when investors turn age 65. The funds invest in a broad range of underlying mutual funds that include stocks, bonds, and short-term investments and are subject to the risks of different areas of the market. The funds emphasize potential capital appreciation during the early phases of retirement asset accumulation, balance the need for appreciation with the need for income as retirement approaches, and focus more on income and principal stability during retirement. The funds maintain a substantial allocation to equities both prior to and after the target date, which can result in greater volatility.

Call 1-800-638-5660 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.



Alan LevensonChief Economist

U.S. Economic Outlook

Economic Outlook: Summary

ENVIRONMENT– Cyclical recovery gains traction in private domestic economy as structural

corrections advance– Macro uncertainty weighing on business expansion plans– Global slowdown weighs on export growth– Fiscal consolidation at all levels of government

LOOKING AHEAD– Real GDP approximately 1.5% in current quarter, 2.25% in 2013– Recession risk low, but few visible engines for near-term acceleration

Household Deleveraging Eases Spending Drag

Debt Stock Is 7% Below 2007 Peak…

0

20

40

60

80

100

120

140

80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12

% D

ispo

sabl

e In

com

e

Consumer CreditMortgage Debt

Sources: Bureau of Economic Analysis, Federal Reserve, Haver Analytics

…And Debt Service Is Nearing Historic Lows

10

11

12

13

14

15

80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12%

Dis

posa

ble

Inco

me

Principal and Interest Payments

Housing Recovery Solidifying

Builders Respond to Pent-Up Demand…

0

500

1,000

1,500

2,000

2,500

3,000

90 92 94 96 98 00 02 04 06 08 10 12

Four

-Qua

rter C

hang

e, T

hous

ands

0

500

1,000

1,500

2,000

2,500

3,000

Thousands, SA

AR

Occupied Housing Units (L)Housing Starts (R)

Sources: Census Bureau, National Association of Realtors, Haver Analytics, T. Rowe Price

…As Supply Overhang Dwindles

1,500

2,000

2,500

3,000

3,500

4,000

00 02 04 06 08 10 12Fo

ur-Q

uarte

r Cha

nge,

Tho

usan

ds

3,500

4,000

4,500

5,000

5,500

6,000

6,500

7,000

Thousands, SA

AR

Existing Homes for Sale (L)Vacant Housing Units (R)

Note: SAAR = Seasonally Adjusted Annual Rate

Capex Pullback: Reload, Not Recession

Capital Goods Orders Show a Cyclical Turn…

40

45

50

55

60

65

70

75

00 01 02 03 04 05 06 07 08 09 10 11 12

U.S

.$ B

illio

ns, S

A

New Orders - Cap. Gds. Excl. Defense & Aircraft

Sources: Bureau of Economic Analysis, Census Bureau, Haver Analytics

…But Profits Suggest It Doesn’t Have To Be That Way

0.04

0.08

0.12

0.16

97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12U

.S.$

/Rea

l Gro

ss V

alue

Add

ed

Profit Margin, Nonfinancial Corporations

Note: SA = Seasonally Adjusted

Cyclical Labor Market Rebound, Structurally Impaired

-150

-100

-50

0

50

100

150

96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13

Cha

nge,

Tho

usan

ds, 1

2-m

o. a

vg.

-600

-450

-300

-150

0

150

300

450

Change, Thousands, 12-m

o. avg.

Construction + Government* (L)All Other (R)

*Excluding Temporary Census WorkersSources: Bureau of Labor Statistics, Haver Analytics, T. Rowe Price

Cyclical Employment Recovery Gains Traction as Structural Drags Ease

Mixed Results on the Fed’s Dual Mandate

Inflation Near 2% Long-Term Objective…

-2

-1

0

1

2

3

4

5

6

07 08 09 10 11 12

% C

hang

e, Y

ear A

go

All ItemsExcluding Food & Energy

PCE Price Indices

Fed long-term objective

…But Employment Level Far From Full

4

5

6

7

8

9

10

11

02 03 04 05 06 07 08 09 10 11 12%

135

140

145

150

Millions

Unemployment Rate (L)Civilian Employment (R)

PCE = Personal Consumption ExpendituresSources: Bureau of Economic Analysis, Bureau of Labor Statistics, Haver Analytics

Fed Deploying Stock and Flow to Spur Recovery

• Open-ended policy links asset purchases to state of economy

• Benefit of conditional commitment to emerge as economy strengthens

• “Substantial” improvement likely entails > 150,000 monthly payroll growth for several quarters, with appropriate underlying demand growth (real GDP 2.25%).

• Watch (beside payrolls) job openings, retail sales, durable goods orders

• Monthly purchases of $40b MBS and $45b UST would add $630b to Fed portfolio by end of June 2013.

Sources: Federal Reserve, Haver Analytics, T. Rowe Price

Fed Portfolio on Track for 23% Growth Through 2013 H1

0

500

1,000

1,500

2,000

2,500

3,000

3,500

Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12

U.S

.$ B

illio

ns

Treasury SecuritiesOther SecuritiesOther Assets

Downside Risk: 2013 Fiscal Cliff

¹Includes capital gains, dividends, and estate taxes²Components do not sum to total due to rounding.Sources: Congressional Budget Office, T. Rowe Price

Elements of 2012 – 2013 “Fiscal Cliff”(Calendar Year 2013)

U.S.$ Billions % of GDP

Bush tax: upper income¹ 89 -0.6

Bush tax: middle income¹ 135 -0.9

2% payroll tax holiday 85 -0.6

Expiration of unemployment benefits 34 -0.2

BCA sequester 65 -0.4

Business and other tax “extenders” 89 -0.6

AMT patch 88 -0.6

Medicare doc fix 12 -0.1

Taxes included in Affordable Care Act 18 -0.1

Caps on discretionary appropriations 75 -0.5

Total² 687 -4.4

Downside Risk: Stumbles in Global Rebalancing

Euro-area Manufacturing Production:Peripheral Weakness Pulls at the Core

70

80

90

100

110

120

07 08 09 10 11 12

Inde

x: 2

005=

100

FranceGermanyItalySpain

China Accepts Slower Growth To Stanch Investment Excesses

-2

0

2

4

6

8

10

12

14

Jan-10

Apr-10

Jul-10

Oct-10

Jan-11

Apr-11

Jul-11

Oct-11

Jan-12

Apr-12

Jul-12

% C

hang

e, Y

ear A

go

Net ExportsInvestmentConsumption

Sources: China National Bureau of Statistics, Statistical Office of the European Communities, Haver Analytics

Contributions to Real GDP Growth

Upside Risk: U.S. Manufacturing Renaissance

• Strong gains in U.S. manufacturers’competitiveness versus major trading partners

• Producers rethink far-flung, just-in-time supply lines

• Energy accounts for 2.0% - 2.5% of manufacturing production costs; roughly 1/3 of industrial energy comes from natural gas.

U.S. Unit Labor Costs Relative to Key Trading Partners (U.S.$ basis)

40

50

60

70

80

90

100

110

120

95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11

Inde

x: 2

002=

100

CanadaChinaGermanySouth Korea

U.S. losing competitiveness

U.S. gaining competitiveness

Sources: U.S. Bureau of Labor Statistics, China National Bureau of Statistics, Haver Analytics, T. Rowe Price

U.S. Economic Projections: 2012 – 2013

Quarterly Profile Annual Profile*

12Q3(A) 12Q4(E) 13Q1(E) 2011(A) 2012(E) 2013(E)

Real GDP (% Change, AR) 2.0 1.2 1.9 2.0 1.6 2.3

Unemployment Rate (%) 8.1 8.0 8.0 8.7 8.0 7.7

CPI (% Change, AR) 2.3 3.5 0.6 3.3 2.3 2.0

Corp. Profits (% Change, YA) 8.1** -0.4 -4.2 7.3 6.0 -4.5

Notes: A = Actual; E = T. Rowe Price estimate; AR = Annual Rate; YA = Year Ago *Real GDP and Consumer Price Index are Q4/Q4, corporate profits are year/year, unemployment rate is Q4 average. **2012 Q3 corporate profits are T. Rowe Price estimate. Forecasts based on data available through November 8, 2012.



U.S. Equities OutlookJohn D. LinehanDirector of U.S. Equity

U.S. Equities Outlook: Summary

ENVIRONMENT– A challenging macro environment, tepid economic growth, and overhangs, such as the

European debt crisis and the U.S. fiscal cliff, continue to weigh on equity markets.– Strong policy responses from central banks around the world have created

exceptionally easy monetary conditions that have reduced equity market tail risk. – Stocks have responded with strong gains so far this year, although the challenging

environment has made the gains feel worse than they are.

LOOKING AHEAD– We are cautiously optimistic, as valuations are reasonable and corporate

fundamentals remain strong.– Low P/E ratios correlate well with strong subsequent equity returns; current valuations

suggest stocks are poised to perform well from here. – Since 2000, the equity market has experienced significant P/E multiple compression,

which could be setting the stage for multiple expansion in the coming years.– Retail flows have heavily favored fixed income funds since 2007. A reversal of this

trend would be supportive of equity markets.– Poor sentiment has left stocks attractive overall, but certain segments stand out.– The macro and the micro are battling it out—which will prevail is the key question for

investors.

A Tale of Two Market Forces

“It was the best of times,

it was the worst of times…”

– Charles Dickens

Source: A Tale of Two Cities by Charles Dickens (1859)

Worst of Times: Macro Uncertainty Continues to Weigh Heavily on Global Equity Markets

• U.S. economic growth slow and still fragile

• Business confidence low and unemployment high

• European debt crisis, U.S. “fiscal cliff,” and Chinese “hard landing” dampening investor sentiment

Best of Times: Stock Market Performance Has Been Strong

• Global equity markets have done well.

• Extremely accommodative monetary policies have reduced tail risks.

• Housing market recovering; median home prices, existing homes sales, and housing starts rise.

Tug of War: Tailwinds Versus Headwinds

Market Tailwinds Market Headwinds

“Tug of War”exists between

market tailwinds and headwinds

Strong corporate fundamentals and attractive valuations

Improving housing and labor markets

Deleveraged consumer balance sheets

Decisive monetary policy actions to support recovery

Risk of recession in euro zone and “hard landing” in China

U.S. “fiscal cliff” risk

Policy uncertainty and regulatory burden

Cautious outlook for U.S. economic growth

Outlook for 2013

– “Tug of War” between macro and micro to continue

– Valuation remains the key variable to market performance.

– Corporate fundamentals are improving.

– Investors are expected to eventually favor equity funds after years of flows toward fixed income products.

Reasons to Invest in the Market: Valuation

1Ratio of market value of all U.S. corporations to adjusted after-tax corporate profits for prior four quarters.Sources: JP Morgan Chase, T. Rowe Price

Price-to-Trailing EPS1

January 1952 to October 2012

0x

5x

10x

15x

20x

25x

30x

35x

'52 '57 '62 '67 '72 '77 '82 '87 '92 '97 '02 '07 '12

S&P 500 Dividend Yield Minus 10-Year TreasuryJanuary 1962 to October 2012

S&P 500 Earnings Yield versus 10-Year TreasuryOctober 1992 to October 2012

Avg. During Expansions: 13.9x

Avg. During Recessions: 12.6x

P/E RatiosAvg. During Recessions 12.6xAvg. During Expansions 13.9xOctober 31, 2012 13.0x

10/31/2012: 13.0x

+0.51%

-12%

-10%

-8%

-6%

-4%

-2%

0%

2%

'62 '67 '72 '77 '82 '87 '92 '97 '02 '07 '12

7.48%

1.70%0%

2%

4%

6%

8%

10%

12%

'92 '94 '96 '98 '00 '02 '04 '06 '08 '10 '12

S&P 500 ForwardEarnings Yield10-Year USTreasury Yield

• Market P/E ratio below its 60-year average during expansions

• S&P 500 dividend yield above the 10-year Treasury yield; third time in 60 years

• Over half of S&P 500 stocks are paying higher dividend yields than the 10-year Treasury.

• Fed model suggests equities are trading at extremely attractive relative valuations.

P/E Ratios and Equity Returns

• P/E ratios and long-term returns highly correlated; the lower the P/E ratio, the higher the predicted return

• Current valuations suggest strong forward equity returns, particularly longer-term.

Notes: Orange line denotes results of linear regression with R-squared of 0.35 for five-year returns.Prices are based on the market value of all U.S. corporations and include quarterly dividends. Valuations are based on long-term P/E ratio.Data are as of September 30, 2012.

Sources: BEA, FRB, JP Morgan Asset Management

S&P 500 Index: Longer-Term Perspective

S&P 500 Closing Level: January 1, 1950 to November 9, 2012

Long-Term S&P 500 Index results have been strong, posting an average annual return of 11% since 1950.

Source: Standard & Poor’s

S&P 500 Since 2000: The Lost Decade

Notes: EPS = Earnings Per Share, LTM = Last 12 Months. Data are as of November 9, 2012.Sources: FactSet, T. Rowe Price

500600700800900

1,0001,1001,2001,3001,4001,5001,600

'99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11

Recession S&P 500 (Operating Basis) - Price

$55.83$38.94

$45.62$54.53

$67.68$76.45

$87.72

$82.54

$49.51$56.88

$83.77$96.90

$102.96 (E)

$0

$20

$40

$60

$80

$100

$120

S&P 500 (Operating Basis) - EPS - LTM

6.0x

11.0x

16.0x

21.0x

26.0x

31.0x

'99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11

S&P 500 Index with Operating EPS (SPX) Price / Trailing EPS

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

S&P 500 Down 6% ...

… EPS Up 84% …

… and P/E Ratio Down 54%

Reasons to Invest in the Market:Strength of Corporate Balance Sheets

11%

-19%

-18%

-17%

-16%

-15%

-14%

-13%

-12%

-11%

-10%

-9%'71 '74 '77 '80 '83 '86 '89 '92 '95 '98 '01 '04 '07 '10

Net

Deb

t % o

f Tot

al A

sset

s

1Includes largest 1,500 stocks excluding autos, financials, and utilities. Net debt represents cash and short-term investments less long-term debt as a percent of total assets. Y-axis is inverted.2Includes largest 1,500 stocks. Corporate cash represents cash and short-term investments as a percent of total assets.Sources: Empirical Research Partners, Standard & Poor’s, Compustat, FactSet

U.S. Corporate Net Debt1

September 1971 to September 2012 (Scale Inverted)U.S. Corporate Cash2

September 1971 to September 2012

• Corporate balance sheets have improved significantly; firms have deleveraged and increased their cash holdings.

• The buildup of corporate cash reflects current uncertainty about growth and investment opportunities.

11%

4%

5%

6%

7%

8%

9%

10%

11%

12%

'71 '74 '77 '80 '83 '86 '89 '92 '95 '98 '01 '04 '07 '10

Cas

h an

d S

T In

vest

men

ts a

s %

of A

sset

s

Reasons to Invest in the Market: Retail Investor Flows Have Strongly Favored Bonds Over Equities

-$399B

$1,122B

-$600

-$400

-$200

$0

$200

$400

$600

$800

$1,000

$1,200

'06 '07 '08 '09 '10 '11 '12

Cumulative Equity Flow sCumulative Bond Flow s

-$100

-$80

-$60

-$40

-$20

$0

$20

$40

$60

$80

'92 '94 '96 '98 '00 '02 '04 '06 '08 '10 '12

U.S

.$ B

illio

ns

1Equity flows include U.S. and international equity funds. Bond flows include taxable and municipal bond strategies. Sources: ICI, Goldman Sachs

Difference between Equity and Bond Flows1

September 1992 to September 2012 (Monthly)Cumulative Flows into Equity and Bond Funds1

January 1, 2007 to September 30, 2012

• Financial crisis has caused investors to strongly favor bond funds over equity funds, countering long-term trends.

• Retail flows expected to eventually favor equities as investors seek higher returns and embrace risk.

Investors have favored bond

funds since the financial crisis.

Bond Inflows

Stock Outflows

Attractive Areas of the Market

– Certain sectors and industries are particularly attractive over the long term, based on current growth prospects and/or valuation.

– In particular, we find the following investment themes attractive:

• Companies with exposure to emerging market consumers

• Derivative plays on housing recovery

• Companies with growing dividend payments

• Providers of new treatments in healthcare

• Companies with exposure to mobile and cloud computing

• Compelling “sum-of-the-parts” valuations in energy

Conclusion

– Valuations are attractive. “Tug of War” between micro and macro will continue.

– Key questions for investors:

• Will Europe be a contagion for U.S. markets?

• How does the U.S. resolve its fiscal situation?

• Which wins over time: macro concerns or valuation?

• When will investor cash flows again favor equities?



International Equities OutlookRobert W. SmithPortfolio Manager, International Stock Fund

International Equities Outlook: Summary

ENVIRONMENT– The last 12 months have been surprisingly strong for equities, rebounding off the

multiyear lows that were hit in September and October of 2011.– Economic policy uncertainty remains elevated but has declined from late 2011

highs, and equity markets, especially in Europe, have responded positively.– Other than financials, market performance has been dominated by more

defensive sectors, such as healthcare and consumer staples.

LOOKING AHEAD– Developed markets will continue to struggle as growth and debt reduction will be

difficult in tandem and safe assets have already rerated.– Major emerging markets should be in recovery mode and should outperform

going forward.– Safer, more defensive areas of the market will stay expensive, but the valuation

gap to higher-risk equities should slowly begin to close.– Interest rates will remain low for the foreseeable future, which should be

supportive of global equity markets.

Equities Have Been Boosted by Policy Action Over the Past 12 Months

MSCI AC World ex-USA 12-Month PerformanceAs of September 30, 2012

90

95

100

105

110

115

120

Sep-11 Oct-11 Nov-11 Dec-11 Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Sep-12

Tota

l Ret

urn

% In

dexe

d to

100

(U.S

.$)

Over the past 12 months, the MSCI AC World ex-USA Index has seen three rallies of nearly 20%, boosted by unconventional central bank actions.

Sources: MSCI, FactSet

LTRO helps to relieve stress in equity markets.

Need for a Spanish bailout becomes explicit.

Draghi: “And believe me, it will be enough.”

German Court upholds European Stability Mechanism.

Federal Reserve announces QE3.

Past performance cannot guarantee future results.

Europe Outperforming

MSCI Europe, Emerging Markets and Japan 24-Month Performance

As of September 30, 2012

75

80

85

90

95

100

105

110

115

120

125

Sep

-10

Oct

-10

Nov

-10

Dec

-10

Jan-

11

Feb-

11

Mar

-11

Apr

-11

May

-11

Jun-

11

Jul-1

1

Aug

-11

Sep

-11

Oct

-11

Nov

-11

Dec

-11

Jan-

12

Feb-

12

Mar

-12

Apr

-12

May

-12

Jun-

12

Jul-1

2

Aug

-12

Sep

-12

Tota

l Ret

urn

% In

dexe

d to

100

(U.S

.$) MSCI Europe

MSCI EMMSCI Japan

Europe has slightly edged out emerging markets for the better part of the last two years, but has broken out over the past three months. In U.S. dollar terms, Japan has hung in there, but also has underperformed Europe.

Sources: MSCI, FactSetPast performance cannot guarantee future results.

Economic Policy Uncertainty in EuropeHas Declined and Stocks Have Rebounded

European Economic Policy Uncertainty Index versus MSCI EuropeAs of September 30, 2012

80

90

100

110

120

130

140

150

160

170

180

Dec

-09

Mar

-10

Jun-

10

Sep

-10

Dec

-10

Mar

-11

Jun-

11

Sep

-11

Dec

-11

Mar

-12

Jun-

12

Sep

-12

Tota

l Ret

urn

% In

dexe

d to

100

(U.S

.$) European Economic Policy Uncertainty Index

MSCI Europe

Economic policy uncertainty matters to markets. And now that the ECB’s policy going forward is relatively more clear, stocks in Europe have responded.

Sources: MSCI, FactSet, policyuncertainty.com

A rebound in European stocks coincides with a decline in overall policy uncertainty.


Defense Wins Championships

MSCI AC World ex-USA, Financials, Healthcare, and Consumer Staples 12-Month Performance

As of September 30, 2012

90

95

100

105

110

115

120

125

Sep

-11

Oct

-11

Nov

-11

Dec

-11

Jan-

12

Feb-

12

Mar

-12

Apr

-12

May

-12

Jun-

12

Jul-1

2

Aug

-12

Sep

-12

Tota

l Ret

urn

% In

dexe

d to

100

(U.S

.$) ACWI ex-USA Financials

Healthcare Staples

Financials have strongly rebounded, but within the MSCI AC World ex-USA, consumer staples and healthcare have been the top performers over the past 12 months.

Sources: MSCI, FactSetPast performance cannot guarantee future results.

Riskless Rally Over the Past Two Years

-0.15

-0.10

-0.05

0.00

0.05

0.10

0.15

Mar

-88

Apr

-89

May

-90

Jun-

91

Jul-9

2

Aug

-93

Sep

-94

Oct

-95

Nov

-96

Dec

-97

Jan-

99

Feb-

00

Mar

-01

Apr

-02

May

-03

Jun-

04

Jul-0

5

Aug

-06

Sep

-07

Oct

-08

Nov

-09

Dec

-10

Jan-

12

% C

yclic

al L

ess

% D

efen

sive

in

Q1-

Q5

Pric

e M

omen

tum

Defensive stocks have outperformed cyclicals for the better part of two years.

Source: Bank of America Merrill Lynch

Cyclicals Leading Performance

Defensives Leading Performance


Global Earnings Forecasts for 2013 Have Come Down

5

10

15

20

25

30

35

40

02 03 04 05 06 07 08 09 10 11 12

FY C

onse

nsus

EP

S

2002 20032004 20052006 20072008 20092010 20112012 2013

Consensus earnings expectations for 2013 have been slashed, but more so in emerging markets where consensus expectations for

next year are down 20% since March.

Source: Morgan Stanley

FY Consensus Earnings Forecasts As of September 30, 2012

Developed Markets

10

30

50

70

90

110

130

150

02 03 04 05 06 07 08 09 10 11 12

FY C

onse

nsus

EP

S

2002 20032004 20052006 20072008 20092010 20112012 2013

Emerging Markets


Defensive Growth Has Been a Durable Theme in Europe

European Defensive Growth Relative to the Market As of September 30, 2012

90

100

110

120

130

140

150

160

Sep-09 Mar-10 Sep-10 Mar-11 Sep-11 Mar-12 Sep-12

Per

form

ance

of E

urop

ean

Def

ensi

ve G

row

th S

tock

s R

elat

ive

to th

e E

urop

ean

Mar

ket

Defensive Growth Relative to the Market*

Defensive growth is characterized by companies that provide a combination of downside earnings protection and exposure to upside earnings potential. Given the challenging

earnings environment, these companies have done extremely well, especially in Europe.

Source: Citigroup Global Markets

*The Defensive Growth benchmark is a custom measure of the performance of European stocks with certain defensive characteristics relative to European stocks in the Stoxx 600 Index.Past performance cannot guarantee future results.

Emerging Market Performance Dominated by Non-BRIC Countries

MSCI Emerging Markets – 12-Month Country PerformanceAs of September 30, 2012

-30

-20

-10

0

10

20

30

40

50

Egy

pt

Thai

land

Phi

lippi

nes

Mex

ico

Per

u

Mal

aysi

a

Col

ombi

a

Sou

th K

orea

Hun

gary

Sou

th A

frica

Pol

and

Rus

sia

Chi

na

Chi

le

Turk

ey

Tota

l

Taiw

an

Indo

nesi

a

Indi

a

Bra

zil

Cze

ch R

epub

lic

Mor

occo

% T

otal

Ret

urn

MSCI EM Country Performance

Sources: MSCI, FactSet

In emerging markets, performance at the country level has been generally strong over the past 12 months, but the BRICs have been underwhelming.

BRICs

Economic Growth in China and Brazil Expected to Bottom in 2012

6

7

8

9

10

11

12

13

14

15

2005 2007 2009 2011 2013 2015

% G

DP

Gro

wth

Performance of both China and Brazil has weighed on emerging markets, but recent economic indicators may be pointing to improving prospects.

Source: IMF

Gross Domestic Product Growth in ChinaAs of September 30, 2012

Gross Domestic Product Growth in BrazilAs of September 30, 2012

-1

0

1

2

3

4

5

6

7

8

2005 2007 2009 2011 2013 2015

% G

DP

Gro

wth

E E E E

’

The Evolution of Risk Taking in the Current Market Environment


Low interest rates and unconventional policy push investors out of safer, fixed income investments into higher-risk asset classes.

Investors move out of fixed income vehicles into equity but mostly stick to the high-yielding, defensive sectors, such as healthcare and staples.

The valuation gap between cyclical and defensive stocks remains wide, but investors have been generally unwilling to increase risk appetite.

Valuations Look Reasonable

On a forward P/E basis, emerging markets continue to look cheaper than developed markets and Europe looks cheaper than the U.S.

Source: Morgan Stanley

Next 12-Months Consensus Price-to-Earnings (P/E)As of September 30, 2012

5

10

15

20

25

30

87 89 91 93 95 97 99 01 03 05 07 09 11

NTM

P/E

DM EM

5

10

15

20

25

30

87 89 91 93 95 97 99 01 03 05 07 09 11

NTM

P/E

USA Europe

Interest Rates Continue to Be Low Around the Globe

Global Central Bank Interest RatesAs of September 30, 2012

0

2

4

6

8

10

12

14

16

18

20

Sep-03 Sep-04 Sep-05 Sep-06 Sep-07 Sep-08 Sep-09 Sep-10 Sep-11 Sep-12

Cen

tral B

ank

Inte

rest

Rat

es (%

)

U.S. U.K.ECB AustraliaChina Brazil

Ultra-low interest rates in advanced economies and declining rates in emerging economies should be supportive of global equities.

Source: FactSet



Fixed Income Outlook:Realities, Risks, and OpportunitiesMichael C. GitlinDirector of Fixed Income

Fixed Income Outlook: Summary

ENVIRONMENT

– Global flight to quality and extraordinary measures by central banks have driven yields across fixed income sectors to historic lows.

– Record flows into bonds have created a strong technical backdrop despite stretched valuations.

– Fundamentals remain resilient, but voracious demand for yield is increasing risk.

LOOKING AHEAD

– Near-term trajectory of interest rates is contingent on progress in the eurozonedebt crisis and U.S. fiscal policy debate.

– Opportunities still exist, but credit research is now more important than ever.

Reality #1 – More Risk…More Return

Cumulative Total ReturnsMarch 2009 – October 2012

By Quality

0

50

100

150

200

CCC B BB BBB A AA AAA

Cum

ulat

ive

Ret

urn

(%)

By Sector

0

20

40

60

80

100

120

GlobalHighYield

CMBS EMDollar

EMCorp.

EMLocal

USCorp.

USAgg.

MBS USTrsy.

Cum

ulat

ive

Ret

urn

(%)

Indices: JP Morgan Emerging Markets Bond Index Global, JP Morgan Global High Yield, JP Morgan GBI-EM Global Diversified, JP Morgan CEMBI Broad Diversified, Barclays U.S. Corporate Investment Grade, Barclays CMBS ERISA-Eligible, Barclays U.S. Aggregate Bond, Barclays U.S. Treasury, Barclays Mortgage-Backed Securities

Notes: Investment grade represented by Barclays U.S. Aggregate Bond Index; high yield represented by JP Morgan Global High Yield Index.

Sources: Barclays, JP Morgan

Reality #2 – Less Risk…More Demand

Yields on High-Quality Fixed Income AssetsDecember 2001 – October 2012

Sources: Haver Analytics, Barclays, T. Rowe Price

0

1

2

3

4

5

6

7

8

9

10

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Yie

ld to

Mat

urity

(%)

U.S. MBSUnited Kingdom 10-yr. SovereignU.S. 10-yr. TreasuryGermany 10-yr. SovereignU.S. AAA Rated ABSJapan 10-yr. Sovereign

Reality #3 – Risks Are Rising

Valuation

Flow Reversal

Liquidity

New Issue Quality

Interest Rates

Valuation Risk –Yields At or Near All-Time Lows Across Fixed Income

1

2

3

4

5

6

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Yie

ld to

Mat

urity

(%)

10-Yr. U.S.Treasury

10-Year U.S. TreasuryOctober 2002 – October 2012

U.S. Investment Grade CorporatesOctober 2002 – October 2012

High YieldOctober 2002 – October 2012

Emerging Markets U.S.$ SovereignOctober 2002 – October 2012

1.68%

6.68%

2.80%

4.52%

10-Yr. Avg.

3.70%

2

4

6

8

10

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Yie

ld to

Mat

urity

(%)

Barclays U.S. IG Corporate

10-Yr. Avg.

5.06%

6

10

14

18

22

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Yie

ld to

Mat

urity

(%)

JP Morgan GlobalHigh Yield Index

10-Yr. Avg. 9.18%

4.5

6.5

8.5

10.5

12.5

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Yie

ld to

Mat

urity

(%)

JP Morgan EMBIGlobal Diversified

10-Yr. Avg.

7.22%


Valuation Risk –…Even Against Backdrop of Deteriorating Credit

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

2005 2006 2007 2008 2009 2010 2011 YTD2012

Upg

rade

/Dow

ngra

de R

atio

(# o

f Iss

uers

)

Investment Grade Upgrade-to-Downgrade Ratio2005 – YTD as of October 2012

High Yield Upgrade-to-Downgrade Ratio2005 – YTD as of October 2012

Sources: Barclays, JP Morgan, Standard and Poor’s, Moody’s, T. Rowe Price

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

2005 2006 2007 2008 2009 2010 2011 YTD2012

Upg

rade

/Dow

ngra

de R

atio

(# o

f Iss

uers

)

Flow Reversal Risk –Massive Flows Into Bonds Since Crisis

Bonds and StocksJanuary 2008 – October 2012

Bonds – Short and IntermediateJanuary 2008 – October 2012

High Yield and Bank LoansJanuary 2008 – October 2012

Emerging Markets DebtJanuary 2008 – October 2012

-25

0

25

50

75

100

125

150

08 09 10 11 12

Cum

ulat

ive

U.S

.$, B

illio

ns

High Yield Bond - Mutual FundsHigh Yield Bond - ETFsBank Loan - Mutual Funds

-5

5

15

25

35

45

55

65

08 09 10 11 12

Cum

ulat

ive

U.S

.$, B

illio

ns

Emerging Market Bond - Mutual FundsEmerging Market Bond - ETFs

Sources: Morningstar, T. Rowe Price

-400

-200

0

200

400

600

800

1,000

08 09 10 11 12

Cum

ulat

ive

U.S

.$, B

illio

ns

Taxable Bond - Mutual FundsTaxable Bond - ETFsU.S. Stock - Mutual FundsU.S. Stock - ETFs

050

100150200250300350400450500550

08 09 10 11 12

Cum

ulat

ive

U.S

.$, B

illio

ns

Intermediate-Term Bond - Mutual FundsIntermediate-Term Bond - ETFsShort-Term Bond - Mutual FundsShort-Term Bond - ETFs

Liquidity Risk – Secondary Markets Are Thin

Total Corporate Securities – Primary Dealer Net InventoryOctober 2002 – October 2012

50

100

150

200

250

300

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

U.S

.$, B

illio

ns

Sources: Federal Reserve Bank of NY, Haver Analytics

Interest Rate Risk – Longer Durations Across Sectors

Barclays U.S. Investment Grade Corporate IndexOctober 2011 – October 2012

Emerging Markets U.S.$ SovereignOctober 2011 – October 2012

4.3

4.6

4.9

5.2

5.5

5.8

6.1

6.4

6.7

Oct-11 Jan-12 Apr-12 Jul-12 Oct-12

Yie

ld to

Mat

urity

(%)

6.9

7.0

7.1

7.2

7.3

7.4

7.5

7.6

Duration (Y

ears)

Yield to Maturity (Left)Duration (Right)


2.5

2.8

3.0

3.3

3.5

3.8

4.0

4.3

Oct-11 Jan-12 Apr-12 Jul-12 Oct-12

Yie

ld to

Mat

urity

(%)

6.7

6.8

6.9

7.0

7.1

7.2

7.3

Duration (Y

ears)

Yield to Maturity (Left)Duration (Right)

Credit Risk – It’s a Seller’s Market

What We Are Seeing:

Increased: As well as:

- CLO issuance - Testing of 1% Libor floors

- Leverage in new issues - Nonstandard call provisions

- Dividend deals - Narrower concessions

- Covenant-lite transactions - Declining deal quality

- Second-lien loan transactions

New Issue of Covenant-Lite Loans1997 – September 2012

Sources: S&P LCD, T. Rowe Price

1.8 3.1 0.3 0.3 0.0 0.5 0.1 2.4

23.6

96.6

2.5 3.47.9

57.049.9

0102030405060708090

100110

97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 YTD12

New

Issu

e V

olum

e - U

.S.$

, Bill

ions

1219

2 2 1 3 1 4

37

125

110 14

75

95

0

20

40

60

80

100

120

140

97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 YTD12

New

Issu

e V

olum

e - #

of I

ssue

s

0

1

2

3

4

5

6

7

8

0 1 2 3 4 5 6 7 8 9 10

Yie

ld to

Mat

urity

(%)

Opportunities Do Exist

Fixed Income Market Yields and DurationsData as of October 31, 2012

1Yield to Worst2Represents tax-equivalent yield, assuming a 35% tax rate

Sources: Barclays, JP Morgan, S&P/LSTA

Bank Loans

High Yield1

EM Local

EM Corporates1

U.S. AggregateCMBSMBS

Short-Term Corporates

EM USD Sovereigns

Municipal BBB1,2

Municipals1,2

IG Corporates

Emerging Markets Offer Three Flavors

Sovereign – External

U.S.$ Local currency-denominatedU.S.$

BBB- BBB+BBB

Sovereign – LocalCorporate – External

Average Credit Rating

JP Morgan Emerging Markets Bond Index Global Diversified

JP Morgan Government Bond IndexEmerging Markets Global Diversified

JP Morgan Corporate Emerging Markets Bond Index Broad Diversified

Benchmark

Yield to Maturity – 4.72%Duration – 7.55 years

Yield to Maturity – 5.69%Duration – 4.70 years

Yield to Worst – 4.09%Duration – 5.29 years

Yields & Duration

Source: JP Morgan

Emerging Markets Local –Currency Component Has Lagged

Currency Impact on Emerging Markets Local Total ReturnsJanuary 2012 – October 2012

95

100

105

110

115

Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Sep-12 Oct-12

Inde

x Le

vel (

Reb

ased

at 1

2/30

/201

1)

EM Local Currency Bond Index Total Performance in U.S.$

EM Local Currency Bond Index FX Impact Only Performance in U.S.$

Sources: JP Morgan, T. Rowe Price

112.7

101.8

Emerging Markets Local –Tight Yields but Attractive Spreads

5.5

6

6.5

7

7.5

8

8.5

9

9.5

10

2007 2008 2009 2010 2011 2012

Inde

x Y

ield

(%)

Average for Period

Yield to MaturityJanuary 2007 - October 2012

Spread to Five-Year U.S. TreasuryJanuary 2007 - October 2012

1.5

2.5

3.5

4.5

5.5

6.5

7.5

2007 2008 2009 2010 2011 2012S

prea

d (%

)

Average for Period

JP Morgan Government Bond Index – Emerging Markets Global Diversified

High 9.73 10/27/08

Low 5.68 10/22/12

Average 7.06

Current 5.69

High 7.08 10/27/08

Low 1.94 6/12/07

Average 4.75

Current 4.98

Sources: JP Morgan, T. Rowe Price

Bank Loans – Less Risk

2046

712

137

195

153

75

223

125

316

64

0

50

100

150

200

250

300

350

2012 2013 2014 2015 2016 2017 2018 2019

U.S

.$ B

illio

ns

December 2008October 2012

Maturity Wall AddressedChange from December 2008 to October 2012

High Yield and Bank Loan Default Risk1998 - 2011

Default Rates Recovery Rates

High Yield Bonds

Bank Loans All Bonds

First-Lien Leveraged

Loans

1998 1.7% 1.5% 38.3% 56.7%1999 4.0 4.2 33.8 73.52000 4.9 6.6 25.3 68.82001 8.6 6.3 21.8 64.92002 7.5 6.0 29.7 58.82003 3.1 2.3 40.4 73.42004 1.1 1.0 58.5 87.72005 2.7 3.0 56.0 83.82006 0.9 0.5 55.0 83.62007 0.4 0.2 54.7 68.62008 2.2 3.9 27.6 58.12009 10.3 12.8 21.9 49.72010 0.8 1.8 41.0 71.22011 1.7 0.4 46.2 67.0Average 3.5% 3.4% 40.0% 68.1%

Note: Defaults are par weighted.

Source: JP Morgan

Bank Loans – Quality Matters

5.7

7.9

14.8

0

2

4

6

8

10

12

14

16

18

BB B CCC%

4.74.9

1.8

0

1

2

3

4

5

6

BB B CCC

%

2.5x the Return,Less Than Half the Risk

1Risk measured by annualized monthly standard deviation of total returns

Source: S&P LCD

Bank Loans by Credit QualityDecember 1996 – October 2012

Total Returns Standard Deviation1

Municipal Bonds – Fiscally Austere Since 2008

Emergency Federal Aid, 24%

Taxes and Fees, 16%

Rainy Day Funds and Reserves, 9%

Other, 7%

Spending Cuts, 45%

States Relied on Spending Cuts and Aid to Close Gaps*FY 2008 – FY 2012

-$40

-$75 -$80

-$45

-$110

-$130

-$107

-$55

-$191-$200

-$180

-$160

-$140

-$120

-$100

-$80

-$60

-$40

-$20

$02002 2003 2004 2005 2009 2010 2011 2012 2013

Sta

te B

udge

t Gap

(U.S

.$ B

illio

ns)

*Percentages are rounded and may not total 100%.Source: Center on Budget and Policy Priorities

• States have done a remarkable job of addressing massive cumulative budget shortfalls experienced during 2009 through 2012. (Note: Not all states are created equal.)

• Gaps were addressed through a combination of spending cuts, withdrawals from reserves, revenue increases, and use of federal stimulus dollars.

Total State Budget Gaps Closed in Each Fiscal YearFY 2002 – FY 2013E

Cumulative budget gaps of $538bn have

been addressed

E

Municipal Bonds – Attractive Tax-Equivalent Yield

Sector YieldsOctober 2009 – October 2012

*Tax-equivalent yield assuming 35% tax rate

Sources: Barclays, T. Rowe Price

5.46%

3.33%

2.66%

1.68%

Conclusion

Inflows into bonds have been record-setting.

Demand for yield has caused historic low yields in many sectors.

Opportunities still exist—but credit research matters.

Risks are increasing in the fixed income markets.

T. Rowe Price Investment Services, Inc.



European Sovereign CrisisKen OrchardPortfolio Manager/Analyst, Fixed Income

European Sovereign Crisis: Summary

ENVIRONMENT– The eurozone’s triple crisis

• Crisis caused by 1) competitiveness imbalances; 2) unsustainable fiscal deficits; 3) high debt levels

– Economic backdrop challenging• Despite a large decline in financial stress, the real economy is not yet improving.

– Solving the crisis• The traditional recipe for solving sovereign crises is not feasible in the eurozone.• Liquidity “bazookas” cannot solve the crisis, although they can buy time.• Adjustment within the confines of the eurozone will be difficult and may take many years.

– The adjustments so far• Competitiveness adjustment is about 50% complete.• Fiscal adjustment is about 40% complete.• Few signs of deleveraging in the private or public sectors• Progress on eurozone integration and mutualization is maybe 20% complete.

LOOKING AHEAD– Three possible outcomes

• Greater Italy – eurozone survives but in a weak and dysfunctional form.• Federal Europe – eurozone survives but process is not smooth. Some casualties possible. • Eurozone breakup – dissolution into shared or national currencies. Preceded by

sovereign/bank default.

The Eurozone’s Triple Crisis

Source: Eurostat

Competitiveness ImbalancesAs of April 30, 2012

Unsustainable Fiscal Deficits

High Debt Levels

Fiscal Budget Balances Adjusted for Extraordinary ItemsAs of June 30, 2012

Total Debt as of March 30, 2012

289.4120.4 135.3 185.9 137.0 154.7 113.6 120.0 63.4 76.6

104.6

76.5 109.092.9

100.3 97.8 114.0

116.6

136.9 101.8

83.4

89.286.390.3 59.054.050.971.166.7

87.4 90.799.2103.2105.4

58.2143.0119.2

706.4

404.9

173.7

0

200

400

600

800

1,000

1,200

1,400

Ireland Netherlands France Spain Eurozone Portugal Italy Austria Germany U.S.

% o

f GDP

BanksHouseholdsGovernmentCorporations

-20

-15

-10

-5

0

5

06 07 08 09 10 11

% o

f GD

P

Italy SpainIreland GreecePortugal GermanyFrance

90

100

110

120

130

140

150

00 01 02 03 04 05 06 07 08 09 10 11 12

Nom

inal

Uni

t Lab

or C

ost Q

1 20

00=1

00

Italy SpainIreland GreecePortugal GermanyFrance

Economic Backdrop Challenging

Despite decline in financial stress…

…the real economy is not yet improving.

-1

0

1

2

3

4

08 09 10 11 12

Inde

x Va

lues

0

5

10

15

20

25

30

07 08 09 10 11 12

%

Italy SpainIreland GreecePortugal Germany

T. Rowe Price Financial Stress Index*As of November 2, 2012

Unemployment Rates As of September 28, 2012

25

35

45

55

65

07 08 09 10 11 12

Indi

ces

Valu

es

Italy Spain

Germany France

Eurozone Composite Purchasing Manager IndicesAs of October 31, 2012

*The stress indicator is the average measurement of z-scores taken from a series of financial stress related indicators.Sources: T. Rowe Price, Haver Analytics, Eurostat

Solving the Crisis

– The eurozone really needs:• Devaluations• Debt restructurings (sovereign and private sector)• Large-scale bank recapitalizations

– But these are not institutionally or politically feasible.

– “Bazookas” cannot solve the crisis, although they can buy time.• Outright Monetary Transaction (OMT) falls into this category.

– The critical question: Can Spain, et. al. adjust their competitiveness, reduce budget deficits, and deleverage while remaining in the eurozone and avoiding default?

• Probably. The problems should be surmountable with the correct policies.• Eurozone integration and mutualization need to increase.• Adjustment within the confines of the eurozone will be difficult and may take

many years.• An economic, social, and political experiment

The Adjustments So Far

Competitiveness Adjustment IsAbout 50% Complete

Fiscal Adjustment Is About 40% CompleteEurozone Periphery Current Account Balance Rolling 12-Month period as of August 31, 2012 Shift in Primary Budget Balance

As of June 30, 2012

Source: Eurostat

0

1

2

3

4

5

6

7

8

9

10

Italy Spain Ireland Greece Portugal France%

of G

DP

Q1 2010 - Q2 2012 change

Remaining to 2015 -2016 target

-20

-15

-10

-5

0

5

06 07 08 09 10 11

% o

f GD

P

Italy SpainIreland GreecePortugal France

Few Signs of Deleveraging

Source: Eurostat

In the Private Sector In the Public SectorBank Lending to Private Sector

As of June 30, 2012General Government Debt

As of June 30, 2012

0

50

100

150

200

250

300

02 03 04 05 06 07 08 09 10 11

% o

f GD

P

Italy SpainIreland GreecePortugal FranceGermany

0

20

40

60

80

100

120

140

160

180

06 07 08 09 10 11 12

% o

f GD

P

Italy SpainIreland GreecePortugal FranceGermany

Three Possible Outcomes

Probability: 40%*

Over the long term…

• Negligible GDP growth

• Partial transfer of fiscal sovereignty = high government debt

• Large income gaps between north and south

• Fiscal and structural reforms are diluted to preserve social stability.

• Banking union, soft fiscal union, and Eurobonds

• Core countries frustrated but not willing to blow up the “European Project”

Grande Italia

(Greater Italy)

Probability: 40%*


• Low GDP growth

• Strict limits on fiscal sovereignty = falling government debt

• Modest income gaps between north and south

• Fiscal and structural reforms are eventually successful.

• But adjustment process is not smooth.

• One to two casualties possible

• Banking union + hard fiscal union + Eurobonds

Föderales Europas

(Federal Europe)

Probability: 20%*


• Higher GDP growth (from lower base)

• Varying levels of government debt

• Large income gaps between north and south

• Dissolution into shared or national currencies

• Driven by social and political exhaustion with adjustment process

• Initiated by a weak or strong country leaving

• Preceded by sovereign and bank defaults

Eurozone Breakup

*The probabilities are derived subjectively and judgmentally and not by way of any standard or proprietary modeling system. Generally, great precision should not be ascribed to the numerical values. The probability conveys the level of conviction with which it is held; a higher value would reflect a greater degree of certainty.

Road Map

September 2013 – German elections

Core country tolerance for bailoutsMid-2013 – Agreement on banking union

Greek eurozone exitApril 2013 – Italian elections

Limits to Spanish social stressMarch 2013 – New Portuguese program

Italian election outcomeDecember 2012 – France, Italy rating downgrades

Spanish rescue programNovember 2012 – Catalonian elections

Known UnknownsItems to Watch



Health-Care Outlook:2012 and BeyondMark Bussard, M.D.Equity Analyst

Health-Care Outlook: Summary

ENVIRONMENT– Health-care sector returns have outpaced the market over a multiyear period.– Medical innovation drives significant shareholder value, provided it delivers

significant clinical benefit.– Entitlement reform must include the largest fiscal liability: healthcare.– Addressing the “fiscal cliff” almost certainly involves addressing long-term health-

care costs, creating long-term uncertainty.

LOOKING AHEAD– A slowly growing economy often favors investment in the health-care sector.– Investing in innovation will continue to be in fashion, regardless of the

political/policy headwinds.– In an environment of change, winners are often underappreciated and losers

overly discounted.

Is Healthcare a Good Sector for Investment?

Health-care sector returns have outpaced the market over a multiyear period.

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

YTD 1 Year 3 Years 5 Years 10 Years

Tota

l Ret

urn

(%)

T. Rowe Price Health Sciences Fund*

Russell 3000 Health Care Index

S&P 500 Index

Total ReturnAs of September 30, 2012

3-, 5-, and 10-year returns are annualized

*T. Rowe Price Health Science Fund’s average annual total returns were 35.25%, 47.93%, 22.85%, 11.20%, and 14.69% for the Year-to-Date, 1-, 3- 5-, and 10-year periods, respectively, as of September 30, 2012. Figures include 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, 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, please call 1-800-638-7890 or go to troweprice.com.


Investing in Healthcare: Our Strategy

– We invest in two broad categories of health-care businesses: “therapeutics” and “services.”

– Therapeutics = medicines/devices that treat/prevent disease (e.g., pharmaceuticals, biotechnology, medical devices)

– Services = essentially everything else (e.g., medical insurance, hospitals, drug distributors, PBMs*, dialysis centers)

– The majority of innovation is in therapeutics (e.g., “medical advances” at the basic level; “breakthroughs” are rare).

– “Innovative services” that reduce cost/improve outcomes (even better, both) are valuable given the enormous cost pressures in the health-care system.

*PBM = Pharmacy Benefits Manager

Investing in Health-Care Innovation:Gilead Sciences* (Nasdaq: GILD)

Gilead Sciences (Nasdaq: GILD)

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Hep C Innovation

HIV Innovation

1986 1996 2006

• No therapy

• ~10-yr. life expectancy

• 20+ pills/day

• ~35-yr. life expectancy

• 1 pill/day

• ~55-yr.life expectancy

– Life expectancy is estimated median survival from time of HIV diagnosis for asymptomatic individuals.

– References:• Anthony Fauci, Immunopathogenic mechanisms of HIV infection, Annals of Internal Medicine, 1996• Ard van Sighem, Life expectancy of recently diagnosed asymptomatic HIV-infected patients approaches that of

uninfected individuals, AIDS, 2010

Gilead’s HIV medicines dramatically improve patient outcomes. Gilead’s medicines have transformed the standard of care of HIV therapy.

*Gilead represented 3.2% of the Health Sciences Fund as of September 30, 2012.

U.S

.$

Investing in Health-Care Innovation: Edwards* (NYSE: EW)

The Edwards transcatheter valve improves patient outcomes at lower cost. Innovation is a win for the patient and the health-care system.

• Traditional Valve– Open heart surgery – Long ICU stay– Two-month recovery time– +$100k cost

• Transcatheter Valve– Minimally invasive – Two-day hospital stay– Short recovery time– Cost effective

*Edwards represented 1.0% of the Health Sciences Fund as of September 30, 2012.

Investing in Health-Care Innovation: Intuitive Surgical* (Nasdaq: ISRG)

The ISRG robotic surgery system improves patient outcomes often at lower cost. ISRG’s technology has transformed the standard of care of laparoscopic surgery.

• Traditional Surgery– Large, open incisions – Longer recovery– Lengthier hospital stay

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• Robotic Surgery– Minimally invasive – Faster recovery– Shorter hospital stay– Improved precision

2005$2B cap

Current$21B cap

*Intuitive Surgical represented 0.34% of the Health Sciences Fund as of September 30, 2012.

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Catamaran* (Nasdaq: CTRX): An Innovative Service Model

PBM** = Managed Care for Rx Drugs– Supply chain disruption drives

opportunity.– Acquisition and consolidation of Catalyst

gives company the scale to compete in the large employer space.

– Catamaran is an established Medicare Part D player.

PBM Market Share

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CMS’s*** Expected Growth in Rx Spend

Catamaran (NASDAQ: CTRX)

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12.3% CAGR

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6.7% CAGR

*Catamaran represented 4.7% of the Health Sciences Fund as of September 30, 2012. **PBM = Pharmacy Benefits Manager. ***CMS = Centers for Medicare & Medicaid Services. ^UnitedHealth Group (UNH) represents 2.2% of Health Sciences Fund as of September 30, 2012. ^^CVS Caremark (CVS) was not represented in the Health Sciences Fund as of September 30, 2012. ^^^Express Scripts (ESRX) represented 1.2% of the Health Sciences Fund as of September 30, 2012.

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Health-Care Reform Overview

– Health-care reform is the most significant social legislation since Medicare’s enactment in 1965. Given President Obama’s reelection, legislation is likely to go forward largely intact.

– Good News: Worst possible outcomes are avoided (e.g., single payer, price controls, etc.).

– Bad News: Unintended consequences are likely due to scope, complexity, and increased or changed regulations.

– Is this good for health-care investing? Depends…

– Winners: Medicaid, hospitals, health-care IT, volume-driven low-margin businesses

– Mixed: managed care, pharmaceuticals, biotechnology, and medical devices

– Losers: No definitive losers

– However, opportunities are plentiful in all groups because winners often are underappreciated and losers overly discounted.

Industry/company-specific dynamics trump reform as a key investment consideration in the vast majority of subsectors.

Conclusions

– Healthcare has been an above average investment sector and will likely remain so.

– A focus on “innovation” in its broadest sense appears to be a winning investment strategy.

– Expected significant increases in health-care utilization, a growing role of the government as payer, and projected budget deficits suggest uncertainties over the long term.

Call 1-800-638-5660 to request a prospectus, which includes investment objectives, risks, fees, expenses, and other information that you should read and consider carefully before investing.

Due to the fund’s concentration in health sciences companies, its share price will be more volatile than that of more diversified funds. Further, these firms are often dependent on government funding and regulation and are vulnerable to product liability lawsuits and competition from low-cost generic products. The fund’s portfolio holdings are historical and subject to change. This material should not be deemed a recommendation to buy or sell any of the securities mentioned.

T. Rowe Price Investment Services, Inc., Distributor.

t. rowe price 2013 investment & economic outlook

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