By Timothy C. Murray

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High yield debt, financial stocks offer value amid uncertainty

An optimistic outcome is priced into most assets, leading to some conflicting signals.

November 2024, On the Horizon -

There is not enough uncertainty priced into markets. While 2025 could certainly turn out to be another year of prosperity, an optimistic outcome is already priced in to almost every asset category, generating sometimes conflicting cross‑asset signals. Against that backdrop, there are two primary questions that will determine the direction of markets in 2025:

1. How long and variable is the lag after Federal Reserve action on monetary policy?

If the lag is lengthy, it will take more time for the effects of Fed easing to work through the economy. In this scenario, we should worry more about the labor market (and potentially a recession), not resurgent inflation. If it is short, we should be more concerned about inflation than unemployment.

Our view is that the lag from Fed easing will be relatively short, making us more positive on growth but wary of sticky inflation.

Fixed income yields are attractive

(Figure 1) High yield bonds offer premium to equities

Past performance is not a reliable indicator of future performance.
January 29, 2010 through October 15, 2024.
Source: Bloomberg Finance L.P.
Earnings yield is 12-month earnings per share divided by stock price. Earnings yield uses forward earnings estimates. Actual outcomes may differ materially from forward estimates.
¹ Fixed income yields (Bloomberg U.S. High Yield, cash, Bloomberg U.S. Aggregate) are yield to worst. Equity yields (S&P 500, S&P 500 ex. Magnificent 7) are earnings yield.
² The “Magnificent 7” is Apple, Alphabet, Amazon, Meta, Microsoft, NVIDIA, and Tesla. The specific securities identified and described are for informational purposes only and do not represent recommendations.

2. Will the hyperscalers maintain the needed very high levels of capital expenditure on artificial intelligence?

The AI revolution drove the 2024 gains in mega‑cap U.S. technology stocks. The durability of hyperscaler (mega‑cap companies that provide cloud computing services) spending on AI will help determine the fate of this group of stocks as well as whether the rally can broaden.

AI spending could be peaking, making 2025 a year of transition. If this is the case, we could see AI enthusiasm take a back seat to other market themes. The economy has also benefited from AI spending—we have essentially had modest growth with an AI kicker that made it look stronger. A capex slowdown would weigh on economic expansion.

Value in non‑investment‑grade debt

High yield bonds and bank loans, which typically have non‑investment‑grade credit ratings, are two segments that offer attractive all‑in yields despite tight credit spreads. High yield bonds and loans feature credit quality that has steadily improved since the global financial crisis, and their current yields more than compensate for their credit risk even if the economy weakens.

Financials expected to benefit from steeper yield curve

In equities, we favor the health care and energy sectors as well as financials, so 2025 could see a resurgence in value stocks over growth companies. Bank stocks in particular should benefit from expanding net interest margins as yield curves steepen with the Fed cutting rates. International small‑caps, with their relatively heavy weights in cyclically sensitive sectors like financials, consumer discretionary, and industrials, also fit this thesis.

Across international markets, Japanese equities stand out even after their strong performance in recent years. Corporate governance in Japan continues to improve. The country has finally succeeded in generating reflation and now needs to manage it effectively, but the level of uncertainty in Japan is meaningfully lower than in other developed markets.

Key takeaway
In an environment where not enough uncertainty is priced into most asset classes, high yield debt, value stocks, and Japanese equities are attractive.

Timothy C. Murray Capital Markets Strategist

Tim Murray is a capital market strategist in the Multi-Asset Division. Tim is a vice president of T. Rowe Price Associates, Inc.

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202411‑4019625

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High yield debt, financial stocks offer value amid uncertainty

Fixed income yields are attractive

Value in non‑investment‑grade debt

Financials expected to benefit from steeper yield curve

Investing during transition

Market Insights

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