Featuring:

Alicia Levine, Head of Investment Strategy and Equities, BNY Wealth

John Flahive, Head of Fixed Income, BNY Wealth

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[00:00:29] Alicia: Hi, everyone. I'm Alicia Levine and I'm the host today of our episode of Your Active Wealth. 2025 is off to the races after a choppy start. Equities have regained their footing while the increase in Treasury yields looks to have abated. BNY Wealth published our 2025 Outlook: Runway in Sight more than a month ago, and we think it's now a good time to discuss recent events and check them against our longer-term views.

Today I'm speaking to Head of Fixed Income, John Flahive, who will provide insights through his bond market lens, while I weigh in with an equity perspective. We're excited to bring together both asset class views to provide you with the full picture of what's going on and what we expect to see in the months and year ahead. Welcome, John.

[00:01:18] John: Good to see you again, Alicia. Thank you.

[00:01:20] Alicia: So, we have to talk about bond yields because yields have risen about 100 basis points since the Fed cut 50 basis points back in September. And it's really accelerated into the beginning of 2025. We've been on quite the ride and we're just a few weeks into the year. So tell us what you're seeing out there?

[00:01:40] John: It's really the story of volatility. It's something that we've been warning our clients about, not to be surprised that the bond market has this up and down, ping ponging with rates all over the place. I mean, if you just think about what happened in the latter part of 2024, as you kind of alluded to, Alicia. We had months where it wasn’t unusual. You have 30, 40 basis points move in yields. You have total returns that are up or down more than 1%. And that certainly persisted here into 2025. The ten-year Treasury yield going up. And in many ways, it looked like the trajectory was going to hit 5% after closing the year a little bit over four and a half. Really, most of the volatility, Alicia, has been experienced in longer-dated maturities, not so much on shorter-dated maturities because they are already pretty pegged to where Fed funds rates are between 4.25% and f4.5%. So there's really not that much movement there. It's really this normalization of the yield curve that has kind of transpired here over the last several months of going from what we experienced in much of 2024 of an inverted yield curve with longer-term yields actually lower than shorter-term yields to now the opposite. The yields on longer-term maturities higher than shorter-term maturities and quote, a normal yield curve.

[00:03:15] Alicia: What's interesting is that U.S. equities have been very strong in the last year or so, even as yields moved higher. But in the last month, equities have given up 5% since the high in the S&P, since mid-December. That's when the Fed cut 25 basis points. But at that meeting, at the press conference, it was really much more of a hawkish cut with an implication that the Fed is going to cut far fewer times in 2025 and the market pretty much rapidly priced in maybe no cuts or one cut for 2025. And that's really where you saw that U.S. equities get softer here. So in the face of strong growth, equities were fine until it looked like the Fed actually might have to pause with some inflation reads that were just a little higher than the market would have liked to see. Now, in the latest inflation prints, equities have stabilized and moved a bit higher. And we now have earnings season, which is starting with earnings coming in much better than expected for all the financials. And typically the financials start earnings season and their comments tend to be a window into the U.S. economy. And so the optimistic views about small business, IPO activity and M&A activity have really helped stabilize the market here. But I think January is really setting the table for a theme that I see, which is the struggle between inflation risk versus growth potential. And I think we're going to see volatility in the equity market as those themes go back and forth.

[00:04:55] John: And I think on the fixed income side and probably again all through the capital markets and in many ways the fixed income market has been leading the volatility, particularly if you take a look of what's been going on since September, as I previously mentioned. So we think volatility will continue and a lot of that has to do with not only are we seeing pretty solid fundamentals in the economy. Particularly, Alicia, you haven't mentioned the consumer, but the consumer is in good shape. We just had a really strong employment number. So much of the theme of what we saw in 2024 with the consumer holding up really, really well, particularly with the wealth effect going on with asset appreciation, stock markets up, people's houses are up, all that and then you have a healthy job market. All of that is underlying where the economy has been very resilient. And that theme continues into 2025. So yeah, we think volatility will certainly be with us. But it's not only just on the fundamental part that I think volatility will be with us, but really I think much of this move in the fixed income markets with rates going higher is not only solely attributable to inflation expectations. It is the lingering concern of what policies may do with the Republican-controlled White House and the legislature. So what's going to happen with things like tariffs? What's going to happen with immigration? What's going to happen with the debt ceiling? And in what time frame are we going to get better clarity? It's almost as if you have this kind of cloud hanging over the fixed income markets and these concerns as it relates to how much inflationary pressures might result from these policies and importantly, how much more concern is there relating to debt and deficits in some of these policies? So just expect volatility because again, while we're hopeful that some of this could be cleared up, there may not be complete clarity until maybe even the end of the year. We'll just have to wait and see, Alicia.

[00:07:05] Alicia: Look, it's the same on the equity side. You know, tariffs and immigration, tax reform, all impact growth, inflation, corporate earnings. I think the area that's gotten the most attention, I think, is tariffs. It seems that tariffs on China are likely to be implemented fairly quickly after President Trump takes office. We already have tariffs on China, so this just would be adding to the level of tariff. But I think the fear in the market here is whether there's a tariff at the border and whether there's a 10% or 20% tariff on all goods imported to the U.S. And I think that's part of the reason that the equity market's been wobbly as we started the year. What's interesting there, of course, is the fear of inflation raising the prices of goods. You know, I’ll just point out that in a tariff situation, the currency tends to stabilize to reflect policy here. The U.S. dollar has actually appreciated against the euro and the Chinese yuan with actually the euro selling off more than the yuan. So the currencies are reflecting already the imposition of tariffs and of course a higher U.S. dollar tends on the margin to be disinflationary. I'm not completely convinced that tariffs will be inflationary, but that is part of what's getting priced into the market. So if it's not, then of course that's quite positive for markets. I think the other thing here on policy is thinking about the labor market. One of the reasons we've been so bullish, of course, is that the labor market, even with some ups and downs last year, looks to be quite stable. And depending on how restrictive immigration policy could be, you could see some contraction in the supply of labor. If there is a bit of a supply shock on the labor side, that of course means the price is higher, meaning wages are higher. That could be inflationary on some of the service-related industries. A lot of unknowns here and I think the market is pricing in the fears of the worst-case scenario. Now, as you said, the good part here is tax reform and extending the tax cuts. As a candidate, President-elect Trump talked about lowering the corporate tax rate on manufacturers who manufacture in the U.S. If that's the case, and they're able to get that through Congress, a 15% tax rate on domestic manufacturers would be very stimulative and in fact, would help hiring in the industrial area, in the manufacturing area. There are some offsetting positive growth impulses here. And I just think as we start the year, the market has really only looked at this policy mix almost as if it's the worst-case scenario. There are real growth impulses here from deregulation, tax policy, and a friendlier face at the FTC, which means more M&A. All that tends to be very positive for the economy and then therefore for markets.

[00:10:10] John: You know, I would agree, Alicia. You look at some of these proposed policies and they could be inflationary. But the bond market really isn't suggesting that it's out of control. The bond market is suggesting that, yes, we could have sticky inflation. But if you look at the move in breakevens on Treasury inflation-protected securities, which we use as a pretty good barometer of what the market is expecting inflation to be over one, three, five-year time periods. And yes, as expectations have gone up certainly since September, but nothing like yields have gone up. So they've gone up only about a third of what yields have gone up. So the market's saying just by definition, there are other concerns that are going on, particularly relating to debt and deficits and not just inflation. December’s overall inflationary numbers were somewhat encouraging, particularly on the core side on CPI. But we still think inflation will trend down toward that 2%. It might be more elongated, but we're not calling for some dramatic move, higher inflation. So our outlook and call still moving inflation from 3% down to 2%. It just might take awhile.

[00:11:25] Alicia: On the equity side, I had a lot of people say to me after the volatility in the first part of January, are you still positive on the markets? You still have your price target, which is 6600 for the end of the year. And I say yes because the fundamentals are strong. So where do we start with, you know, when we look at the equity market and where we're going in the next 12 to 18 months? And the first is earnings and earnings are expected to be up double digits this year. As I said, we started with the financials, which beat estimates. Very optimistic statements from all the CFOs and the CEOs. We think that earnings estimates can beat expectations by about 2% to 3%, which is where BNY is with our equity team. And we think that we'll have about 12% to 15% earnings growth in 2025. We see the S&P rising about 10% to 11% from here. And so we're just very bullish on that. Now, as it relates to the multiple, there's been concern about the multiple, because we started the year with a 22x forward multiple, which really is historically high. And what I'd say to that, which is what I've been saying for the last couple of years, is that the companies are simply healthier. So driven by large cap tech and communications services, margins are higher and we're in a higher margin world over the last 30 years, very slow tick rate upward. Corporate margins on average are 13.5% for the S&P. But for the tech sector, it's double at 27%. And with stronger companies and better free cash flow and higher margins, you can support a higher multiple. Multiples are a terrible way to time the market and a terrible way whether or not to decide to invest. So I'd say a higher multiple could provide volatility if news is not positive, but it's not a reason not to be fully invested.

[00:13:21] John: Curious, Alicia, you know last year was led, everybody knows by the mega tech growth companies. But is 2025 a year of any pivoting, any major changes? What are you liking in sectors? Do you see the market broadening out? Maybe we're not as reliant on the Magnificent Seven?

[00:13:41] Alicia: So I do think that the Magnificent Seven really needs to be the bedrock of how we think about the year and moving forward. Because, you know, if it is the case that the Fed can't cut more than 1 or 2 times in 2025, the tech stocks really act as offense and defense. They work as offense because they're growing faster than the other companies in the S&P with better free cash flow margins and higher corporate margins. So that's the offense part. The defense part, they simply don't need to borrow to grow. And they're immensely profitable with very large cash available on the corporate balance sheets. So because of that, if there's any volatility in yields, if that continues, we think that the large cap tech will be very resilient. Having said that, we do think cyclicals will do well this year. We're in the kind of environment, in a deregulatory environment, particularly changes at the Federal Trade Commission to be more lenient on M&A. That tends to work really well for smaller cap companies – mid-cap and small cap as well. And with the reshoring theme, and if there is a decrease in the corporate tax rate for domestic manufacturers, that should be great for industrials as well. So we like tech, we like industrials, we like financials. And that seems to be the policy mix that the administration really wants to support. And I'd say stick with large cap tech, still the best companies out there. But you really have to broaden your view. And I think this is a world where the other 493 do quite well. In addition, this year, John, the other 493 earnings are rising higher than they did last year. And so the differential between the Mag Seven earnings and the 493 earnings is actually shrinking. And so therefore, I just think you have a broader market this year. Last year when we did our outlook, you looked at the yield forecasts and you thought it would be a range throughout the year, somewhere between 3.25% and 5%. Are you still comfortable with that and you still stand by that?

[00:15:47] John: One of the things we decided coming into 2025, because historically, we've always given a year-end target of exactly where the 10-year Treasury might end. We decided it probably makes more sense to express this concept which is volatility is going to be with us. And so that's where we get that 3.25% on the downside and 5% to the upside, which almost by definition means that we think that interest rates are in a zone when we begin the year at 4.5%, kind of near the peak, and shouldn't necessarily go much higher than where we are. And we always leave the window open that if something cracks, if we're wrong with the economy. Our expectation for growth in 2025 is for GDP to range from 1.5% to 2.5%. But if it happens to slowdown for whatever reason, geopolitical risk, global growth slows down. There's the potential for interest rates to clearly go lower. We're going to follow the path of inflation. And if we're calling for inflation to eventually get lower, then eventually rates can go lower. We're looking for strength in the economy. We're not looking for a recession, but we're also looking for some moderation of growth compared to what happened in 2024. But the one kind of lingering uncertainty I've been saying is that this level of U.S. government debt and deficits should in many ways have that cloud over the fixed income markets. The market's kind of pricing in the worst of policies. And if it comes out where we're actually not experiencing the worst and Washington, D.C. is actually mindful about handling the deficit and being a little bit more hawkish to not make the deficit worse, then again, that might be the catalyst for rates to go down. But the main point is volatility. But also importantly, just like in 2024, we think that the income that is now available in this rate environment should produce positive total returns despite prices going up and going down much like 2024. We had positive total returns. You had negative price returns, but it's that income level at these yields that should act as a guide for what your returns could be. And we could come into a scenario where you have not only that income, but some price appreciation. So, we are expecting the bond market to act as a traditional ballast against volatility in other portions of the capital markets.

[00:18:23] Alicia: With all that, if you had a client today with cash ready to put to work, in terms of duration, where would you want to allocate today on the curve?

[00:18:36] John: Regardless of where you go on the curve, we have and continue to say don't overstay your welcome in cash. So to the degree you have excess cash, we prefer you get that into longer maturities. Every client's different depending on their risk tolerance. But as an overall thing, we do believe in an intermediate maturity type of profile. Average maturity between 5 and 10 years. And we think that will serve you well in the years to come because your entry point in these type of yields, we haven't really seen these type of yields in over a decade. So it's somewhat compelling.

[00:19:12] Alicia: So, John, you've just said that you find the intermediate portion of the curve attractive, but I'm wondering what you're thinking about other parts of the fixed income market. Where are there other opportunities?

[00:19:24] John: Yeah, great question, Alicia. Most of the recommendations we've had over the last couple years are going to continue here into 2025. And what I mean by that is I do think it's important to have a diversified fixed income solution set. And you never want to have all your money in one particular basket. And while municipal bonds are attractive and produce some pretty interesting and historically compelling taxable equivalent yields of 6% to 7% for an intermediate diversified municipal bond portfolio. But we still like high yield and floating rate high yield because our outlook for corporate profitability as Alicia mentioned is still really solid. So, we don't see a crack or a credit concern within the corporate bond market, the high yield market, or the investment grade corporate market. So particularly for those pockets of money that are deferred, whether it's your IRA or you have a low tax bracket scenario, it is still appropriate to own that. Now, historically, those spreads or the differential in yields between those markets, either high yield floating rate, high yield, corporate market, emerging market, they're narrow, but the nominal yields are still really attractive. And so we've maintained a neutral bias on some of those what we kind of call satellite solutions to augment the returns of what you might be getting in the municipal bond market, and also provide diversification, liquidity to it. Opportunistic fixed income, that takes advantage of what we're going to see here in 2025, much like we've seen here in the last 3 or 4 months, is volatility in interest rates and volatility in these spreads that could come about. We think it's important to think about that as a potential allocation as well. So diversification amongst both taxable and tax-free we think makes a lot of sense. And we think again, that will drive better return than just having a one single solution approach within your fixed income allocation.And what about you, Alicia? I mean, when you're thinking on the equity side, where are you recommending for opportunities and where you think is going to be the best place to be in 2025?

[00:21:48] Alicia: It's interesting, John, because we've been overweight U.S. equities for many years now. We've been neutral on small and mid cap while we've been overweight U.S. large cap. And we've been underweight emerging markets and developed international. And we come into the year very close to that allocation for the reason that we expect the U.S. dollar to be strong because of the policy mix and also because the growth in the U.S. is simply stronger than the rest of the world. I mean, since Covid started, U.S. GDP is up about 12%. And our G4 partners, the closest is Europe, up about 4.5%. So U.S. growth is really separating from growth in the rest of the world and other developed countries. And because of that, the equity markets are simply stronger here. So, we maintain our overweight to U.S. assets, U.S. large cap. But in the past, the last couple of years, it's really been driven by large cap tech. The top ten stocks of the S&P, the Mag Seven. But we think this is a year where the 493 get to work. They get to work on the earnings side. So earnings growth will be strong for the other 493. The differential in the growth rate between the top ten and the other companies in the S&P will start to close, and that means a broadening of the market. So that means the cyclicals will work and we already see it in the financial sector that's really had a great earnings season so far for the fourth quarter, beginning of 2025. We like industrials here because we think the policy mix, particularly if the corporate tax rate is lowered to 15% for domestic manufacturers, is great for industrials. It also helps some down cap companies in mid and small cap. So we like those areas, always prefer the U.S. as really the best markets, the best companies and the best fundamentals compared to the rest of the world. So we're sticking where we are. But I'd say our conviction here is really that the market is going to broaden.

[00:23:52] John: And also it's going to be a bumpy ride, but it seems to all makes sense. So thank you for your comments, Alicia.

[00:23:57] Alicia: It is a bumpy ride. It's that inflation and supply of bonds risk versus the upside from the growth policies. And that's just going to make for a really interesting year, John. And I hope more conversations like this with you. Thank you today for your insights and joining me today. It was an interesting and enlightening conversation about where we thought the year was going to start and how it's actually started. Here at BNY Wealth, we capitalize on the expertise of our investment professionals to monitor all economic and market events to help our investors and our clients navigate markets. We recommend timely portfolio adjustments for the benefit of our clients, and your portfolios are always tactically allocated to take advantage of the best opportunities in the next 12 to 18 months. To learn more about these views and others as they relate to our 2025 outlook, we invite you to read our 2025 Outlook: Runway in Sight on the BNY Wealth web page or reach out to a BNY Wealth representative. Thanks for joining today and we'll see you on our next episode of Your Active Wealth.

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