The stock market has exhibited a pattern of annual themes in recent years, with 2024 dominated by Artificial Intelligence (AI) and 2023 focused on recovery from the previous year’s recessionary fears. This contrasts with historical trends that typically spanned multiple years, such as the quantitative easing-driven momentum from 2012 to 2014 and the dot-com bubble from 1994 to 2000. The question arises whether 2025 will follow the recent pattern of annual themes or revert to longer-term trends. The anticipation is for another thematic year, specifically focusing on diversification due to the current market conditions.
A review of 2024 market performance reveals a surprising parity between the S&P 500 and the NASDAQ 100 indices. While the NASDAQ, heavily weighted with AI-related companies like Amazon, NVIDIA, and Alphabet, was expected to outperform, the S&P 500 kept pace. This can be attributed to the widespread adoption of AI across diverse sectors. With 61% of large American companies planning to integrate AI for task automation, the benefits of this technology are not confined to the tech sector but extend across the broader economy, thus bolstering the entire market.
The current market valuation, as indicated by the S&P 500’s price-to-earnings (P/E) ratio of around 28, raises concerns. Historically, such high valuations have preceded bear markets, as witnessed in late 2019, mid-2008, early 2001, and late 1997. However, the current situation differs from the previous instances, as those high P/E ratios occurred after the onset of bear markets, primarily driven by declining earnings. The present high valuation is more akin to 1997, the peak of the dot-com bubble, where stock prices were inflated by speculative future growth. If the anticipated transformative impact of AI fails to materialize, a market correction similar to the late 1990s is possible. The uncertainty lies in the timing of such a correction, making it difficult to strategize effectively.
Given the high market valuation and the uncertainty surrounding its future trajectory, 2025 is predicted to be the “Year of Diversification.” Investors are expected to seek alternatives to stocks, particularly avenues that offer both participation in the current market strength and downside protection. Corporate bonds, currently yielding 7.3% for companies with BB+ or lower credit ratings, present an attractive alternative. Closed-end funds (CEFs), specifically those focused on corporate bonds, offer an even more compelling opportunity, with potential dividend yields exceeding 10%.
A recommended strategy is to preemptively invest in these high-yielding CEFs, such as the PGIM Global High Yield Fund (GHY), which offers a monthly dividend yield of 10.1%. Concerns about defaults in high-yield bonds are often exaggerated. Even during severe economic downturns, default rates rarely exceed 10%. A diversified CEF like GHY, holding bonds from 405 different issuers, significantly mitigates the risk of substantial losses. Furthermore, the current default rate on high-yield bonds is around 1%, negligible for most CEFs, including GHY. The fund’s management by Prudential, a reputable financial institution with extensive resources and expertise, further enhances investor confidence.
GHY’s portfolio demonstrates robust diversification across various sectors, including media, consumer cyclicals, energy, industrials, and financials, limiting exposure to any single industry. Its global reach, with 47.5% of assets based in the US, positions it well for a potential shift in capital flows. As US interest rates are expected to decline in 2025, investors may seek higher returns in other markets. The fund’s consistent dividend payouts, with no reductions in the past five years, and its ability to out-earn its distributions in 2024, indicate a sustainable yield.
The fund’s current discount to net asset value (NAV) of 4.7% further enhances its attractiveness. This discount, a key valuation metric for CEFs, has steadily narrowed throughout 2024. If the anticipated shift towards high-yield alternatives materializes in 2025, the discount could further shrink, boosting returns. Even without significant changes in investor sentiment, GHY’s strong historical performance, outperforming the corporate bond benchmark index fund over the past decade, suggests further potential for appreciation. GHY’s double-digit yield, historical performance, and diversification benefits make it a compelling investment option, especially considering the current elevated stock market valuations. It offers a robust alternative investment avenue for those seeking income and a hedge against potential market volatility.
