Q4 '25 Asset Allocation Viewpoints Webinar: Balancing Act

Christina Noonan

Hello everyone and thank you for joining us for this quarter's Asset Allocation Viewpoints webcast, “Balancing Act,” brought to you by T. Rowe Price’s Multi-Asset Division. I'm Christina Noonan, a portfolio manager within Multi-Asset, and I'll be your host for today's discussion. There's no shortage of topics to discuss today, from extended valuations to AI, fiscal stimulus, and even gold, so we'll be sure to touch on those as well as how we're positioned in the current environment.

But before we begin, a couple of housekeeping items to note. Beneath your video player, please use the right-side panel to take our post-event survey. On the left, you'll find more information on Global Asset Allocation Viewpoints and, at the top of your screen, you'll find the link to register for our final webcast of the year, our Global Market Outlook coming up in November. Slides will be available to download with the replay of today's session.

If you've joined these webinars before, you'll notice we're coming to you from our new studio at our global headquarters in Baltimore. We're excited to be here and we're recording this session in advance as we finalize some last broadcasting logistics, but we look forward to coming to you live again soon.

With me as always is Sébastien Page, who you may recognize from Bloomberg, CNBC, and LinkedIn. He is the Chief Investment Officer and head of Global Multi-Asset, overseeing an investment team dedicated to multi-asset portfolios. He is also the co-chair of the Asset Allocation Committee, responsible for tactical investment decisions and an author of two books, “Beyond Diversification” and “The Psychology of Leadership.” Thank you for being here, Sébastien.

Sébastien Page

Okay, I am so excited today for two reasons, of course the new studio, of course I am going to say that. But our special guest, Adam Parker. We almost never get external guests but this one today is…no pressure, Adam. Adam’s going to be awesome today. Not to put too much pressure on you.

Christina Noonan

Adam is the CEO and founder of Trivariate Research. He brings more than 20 years of experience covering markets and has been recognized as a top strategist and quantitative researcher. You may also recognize Adam from CNBC. Excited to have you here today, Adam.

Adam Parker

I’m also excited to be here today and I hope I can live up to your expectations.

Christina Noonan

So as I mentioned, we have a lot to cover, especially on how we're navigating the current environment and our thoughts on tactical asset allocation. So with that, let's start with you, Sébastien. So we met last in mid-July and markets were reaching all-time highs after Liberation Day. Flash forward to today, markets up another 6% or so on AI, dovish Fed, noise turned down on tariffs. Can you talk about how you and the Asset Allocation Committee are thinking about markets today?

Sébastien Page

Well, we just had a meeting and we are having intense debates between the bulls and the bears. Christina, on a scale of one to ten, ten being the most intense debates between bulls and bears, and one being we all agree, we're close to a ten. We have bulls on the committee and bears on the committee. And we have people who are comfortable neutral. Our portfolios are ultimately neutral, but overall we remain positioned neutral on risk assets, stocks versus bonds, short duration and long diversification.

We'll talk about that today, but I want to take a moment to talk about the all-time high, what you mentioned because you know, I watch Adam Parker on CNBC and he says, well, valuations don't matter. Well, do all-time highs matter? And maybe, just to start the discussion, I'll say, yeah, valuations when they're this high, they can matter. So I went back and looked at data from 1994. So, over 30 years of data. And I looked at the average rolling 12-month return for the S&P 500. That's pretty good, actually, it's 10%. If you go back to 1994, stocks have been awesome. The S&P 500 has been awesome.

Now, here's the question: What happens to forward 12-month stock returns when the S&P was at an all-time high over these last 30 years? So you would think returns would be lower and this kind of rhymes with you, Adam, saying valuations don't matter. All-time highs, average for 12-month returns is 13%. It's actually higher than the unconditional average, so there's momentum behind all-time highs.

Now where I start to challenge Adam a little bit is on that same data sample going back to 1994, what happens when the price/earnings ratio is above 21? We're somewhere in 22, 23 range today. There are 17 observations. The average does go down from 10% to 7%. So yes, the average is lower, but here's what's interesting. And here's my sort of counterargument: valuations do matter for you, Adam. I'm throwing a lot of  arguments -

Adam Parker

I'll unpack this, I'll unpack it.

Sébastien Page

But here's the thing.

When stocks were at an all-time high, going back to 1994, looking at forward 12-month returns, I found that the probability of a muddle through return between 5% and 15% craters. In other words, when valuations are high, you either get extreme positive returns, right? You're riding a bubble, or you crash. I'm exaggerating. But the probability when the price/earnings ratio is above 21, this is how I parsed it for this exercise, that you get a model to return of 5% to 15% was only 18%.

Adam Parker

Explains the polarization in in your -

Sébastien Page

The committee? Yeah, exactly.

So I'm just going to say that the economy is doing fine. It's actually doing better than fine, right. And you're hearing the positive factors behind the economy every time you turn on the financial media: the Fed is cutting, we have fiscal spending, M&A’s picking up, you have corporate earnings growing at 18%, you have a strong consumer, high end consumer, the top 10% of wage earners represent about 50% of consumption in the country. And yeah, they spend, they have stocks, so they feel good.

The issues are for the bears on the committee. The unemployment data has definitely softened in terms of slower hiring and you know, as we're recording this, the buzzword of the moment is cockroaches, because Jamie Dimon went and said of the fraud-based defaults that have occurred recently: there's rarely just one cockroach in the kitchen. So people are starting to worry about credit markets.

My view is there isn't a lot of borrowing, there isn't a lot of leverage. The government is levered, the government borrowing is huge, but overall in the credit space, the ratios that we typically look at to estimate probabilities of default, they look pretty good. But nonetheless, this worries markets. And then of course just valuations and speculation. Again, when the price/earnings ratio is above 21, the probability of a model 5% to 15% is only 18% of the time, right? So that's kind of my point on the fragility of high valuations.

So my question for Adam and I'm jumping ahead because I know you have a question for him and you can ask it first. But my question for Adam is going to be, do valuations really don't matter?

Christina Noonan

But okay, yeah, we'll get, but let's -

Adam Parker

I won't forget.

Christina Noonan

Let's get your broad thoughts on, thought in your most recent monthly webcast, you sounded pretty optimistic like markets still had some upside from here. Can you talk about your high-level views on valuations?

Adam Parker

Sure. I mean the pillars of the bull case for U.S. equities are this dream of AI-fueled productivity, which helps margins, and stocks go up and margins go up. And as you mentioned, a dovish skew to the Fed, and so anything that you said that challenged the AI productivity dream and the dovish Fed kind of hit the wall and fell to the ground, like there wasn't a lot.

I think when the bear cases come up, you hit on some of the ones I hear for sure, they're really around when will we give up or get concerned about return on hyperscaler capex, all the spending from Microsoft and Meta and the big companies. I think you need capex to go up for this rally to continue, certainly they can't pause or decline it. And I think you need, by 2026, some cases from big companies that tangible that they're gonna benefit our productivity, that they can grow their revenue without a lot of hiring. I think if you see those things, the bulk case will be intact, but that's a legitimate bear case.

The second is, as you mentioned, unemployment. I hear it more from AI, so good that white collar unemployment will go up, that recent grads have had to struggle a little bit. And so people worry a little bit about what are all these unemployed people going to do and how will the resource going to be deployed again? I think it's a concern but not something I positioned for in the next six to nine months.

Sébastien Page

And you're worried about the lack of hiring in the economy because there's not, there's no firing either.

Adam Parker

Yeah, I'm kind of a U.S. equity-focused guy. So 40% of the market cap is less than 2% of the employees. I want companies to grow without net hiring because their margins go up. And I'll die on the hill that stocks go up when the margins go up and that's related to your valuation issue, right?

And I think the third thing is longer-term and somebody asked me, ‘hey, are you at all concerned about government deficit?’ You sort of feel, gosh, I don't want to be like no, not worried, we run at war-type deficit for 20 years. If I think the question is, ‘should I position?’ Should you position this giant amount of capital for that mattering in the next three to six months? That's a different question and I think the answer has been no for most of the last 20 years.

So I'm worried because that could cause some pretty big rotations underneath. But I don't think it's the next three to six, nine month issue either. So those are the bear cases. You mentioned another one: sentiment valuation.

So let me get to that valuation thing without rambling too much.

What we wrote a few months back is that we don't think valuation will work for picking stocks. There were two points of that: fundamental and microstructure, and one set of caveats.

The fundamental point is stocks that are getting more expensive are likely beneficiaries from AI on productivity or have business models that are impregnable. Stocks are getting cheaper are likely disrupted. So if I use mean or reverting valuation in the old school way, all we're doing is buying stocks have a higher probability of being disrupted and shorting or selling stocks have a higher probability of benefiting or being impregnable. And I think that won't be useful.

I think the microstructure, meaning how is quant money run when we were formulating our investment heuristics, there was a lot of longer-horizon people 12 months now, almost all quantities on less than a 10-day horizon. People have hundreds of longs, hundreds of shorts, they’re valuation-neutral. So they're long MicroStrategy and short Palantir or across the stack. So they don't really care if valuations at the market level are extreme, they don't care if low quality securities are working, because they're long and short across the stack. So we could create a bit of an exaggeration or amplification on how long this could last also. So that was kind of my point in valuation. The exceptions were I think valuation does work in timeframes longer than five years. So when you're asset allocating a ton of money like you guys are, you have to be more mindful of the long term, you know, issues. I don't think it's effective at all and things like less than three years.

Sébastien Page

So the interesting thing is, they haven't worked for five years.

Adam Parker

Yeah. So we're approaching somewhere between five and ten. Somewhere between five and ten. And I'm worried a little bit. Could the dynamics could be longer this time? There's levered ETFs and other things that can really exaggerate this. But I think it's the way quant money’s run. I think it's a little bit of the ETF world that causes this and I think AI is causing the market to anticipate winners and losers and it's just gonna make it tough.

We have one last exception that says we have shown in the work that you don't wanna buy the cheapest decile of stocks. So the idea that I could come to you and say, oh, this thing trades at six times earnings and nobody else in the world sees it. Well, it's probably an airline or something else that it may be a good stock. General Motors, as we're recording, is up a bunch today. It's a low optical P/E but I'm not confused why it's low, right? Right. So I kinda and that's an inferior bucket on average and then the most expensive decile and easy to sales too historically. This has underperformed because you have high expectations that ultimately aren't that. So I caveat it all over the place, but generally I think in the middle second to ninth, middle 80%. I'm not sure I want to buy cheaper stocks and so expensive I don't think It's going to work.

Sébastien Page

I think, Adam, it’s the most important discussion to have. When do valuations matter? And when do we think they will matter in the current environment either to pick stocks or to allocate cross assets? So, I like the contribution making to the debate here.

Adam Parker

I mean at the market level, you mentioned 21 times being expensive, you know and I think I get less of this recently. And remember I'm a U.S. equity focus, so whenever I talk to someone who's fixed income focus, they're going to run more bearish or cross-asset they have to, you have to balance different things.

And I'm like in the U.S. equity world, but if people bring up things like CAPE or Shiller P/E or grant them sort of a view on valuation being high. In my world, all they're saying is margins are going lower for the average company. And so the reason I don't love the historical comparison is because when the market traded at 17 times forward, which is the long-term average since forward earnings data existed in 1978, eight of the biggest 10 companies were energy and margins were lower. And so a little bit, I'm not saying, hey, more multiples going to the moon, but I think there's some logic why we could oscillate at higher multiples from now for the next five years than in the past and that's maybe it's 21, maybe it's 22 you know, but that's the more the debate than if you think we're going back to 17, all you're saying is margins are getting annihilated for U.S. equities.

Christina Noonan

Yeah, and still a way off from valuations of the tech bubble, but so let's pivot to the AI, a theme that you touched on. We know investors have been piling into AI-related names, capex spend, huge driver of economic growth, even masking weakness in areas such as housing, manufacturing. I’ll ask you a tough one, Sébastien, but the B-word that keeps coming up. Are we in a bubble? We've touched on the valuations but want to hear your thoughts on whether we are in a bubble or approaching a bubble.

Sébastien Page

I think there's room to run here. You know these investments aren't levered and that's a big difference from prior bubbles. I have a committee member who likes to say there is no credit cycle, so we could keep running. And I think Adam will agree with that. Are we somewhere along the path towards a bubble? Probably the price-to-sales ratio is higher than during the dot-com bubble. Actually, the price-to-book ratio is higher than during the dot-com bubble and the price/earnings ratio is up there and the dividend yield is about the same than it was during the dot-com bubble. So things are starting to feel very speculative.

You know, Christina, I went to Palo Alto recently. Actually, it was my first time in Palo Alto and I talked to tech entrepreneurs and CEOs and founders of tech companies. First of all, you arrive in San Francisco and you look at billboards. And every single billboard is AI. AI this, AI this, AI this. Then you get to Palo Alto and first of all, I was the only one wearing a suit. Suits aren't in in Palo Alto, I learned, and you know, real estate is through the roof and there's a lot of activity and enthusiasm. I would say a bubble-like atmosphere. And I'm speaking to this group at dinner and I kind of realized these founders, like maybe half of them, are billionaires on paper, right, given the valuations?

I pulled this up for our discussion today. In 2015, there were only 82 so-called unicorns. This is an estimate I could find. I actually used AI so maybe the estimate is wrong. We’ll get back to that. But let's-

Adam Parker

There's an irony in that we'll get to the full argument in a minute. We'll get to the irony of you using AI to get your estimate.

Sébastien Page

Roughly 100 unicorns 10 years ago. Okay, the count, this is a more accurate count because it's recent data. How many unicorns today, do you want to guess? So we had about 100 in 2015. We have 1,539. So, there's something going on. There's something in the air.

There is speculation if you look at underneath the stock market stocks, especially in small- and mid-cap that have no revenues, that are higher risk, higher beta stocks, they're outperforming stocks that screen on quality and value factors. So it is kind of starting to feel like we're there, but I'm not going to use the B-word.

He’s kind of one of the gurus on valuation, he went on CNBC and they asked him the same question and he said I'm not going to use the B-word because earnings are behind a lot of the price appreciation. And that's super important. We're going 12% earnings at quarter after quarter.

Adam Parker

You phrased this AI bubble and so if I laser on the way you prefaced it, I would probably and I only get yes or no with a gun to my head I'll say no, but I totally agree with Sébastien that if you look in the smid-cap universe and look at the number of companies that are up, say 100% in a rolling six-month basis. We're getting 80% of the way toward where we were at the tech bubble right at the financial crisis recovery and the COVID recovery when we had massive stimulus. What’s weird is, those three were all accompanied by massive fiscal and monetary stimulus by the government as reaction to a recession. And this time we're getting that playbook without the recession or the stimulus that caused it. So it feels a little speculative.

And the number of profitless companies, however you define it, if you use profitless index or other stuff, you'll find it's getting a little crazy in the small-cap universe. But in terms of the AI stuff, if I just focus on like U.S. equities in the large cap universe, I think it's true because the fundamentals are pretty good and most of this is going to come at ‘27 and ‘28 when we get productivity from the company. The data center capex, if you listen to Jensen [Huang], NVIDIA CEO, maybe he's biased, but it looks like you can have 100% data center growth in the next 18 months. I think that's mostly money. Good. I don't know about the three trillion number in 2030. That could be crazy talk. But for the time being, I think I have enough of a runway, fundamentally, that I don't think I want to say, ‘it's all a bubble yet.’ I guess that's how I'm thinking about it, yeah.

Sébastien Page

And also not all valuations are created equal. What you're talking about, the profitless small- and mid-cap, is one thing happening. But one point that you've made about valuations in the current level, even made it earlier today, is margins are really high and their margins that are associated with moats with large technology companies that have the ability to grow earnings. You go back to the mid ‘50s. The margins on the S&P 500 were around 6% and they are almost double that. If you actually draw the chart, you see margins go up. So you justify a higher P/E that way, the market is more technology-oriented.

Adam Parker

Because the gross margin is a proxy for sustainability. That’s why I like the gross margin line. Some people say, why do you go to net margin? Well because the gross margin, if I have a business model that commands gross margin, it probably is something recurring, a technology mode, a pricing power. So it means my three-year forward numbers are a little less. I think the stock market also—and I don't think people think about this everyday—probably has less downside to margins than previous cycles, because there aren't that many businesses that manufacture things where pricing can get crushed. It used to be in the old days, I gotta track production versus consumption because as soon as it gets close, man, I don't want to overbuild; pricing gets killed. I used to be a semiconductor analyst. And you see that in DRAM [chip].

Sébastien Page

And anything that's commodities related, if you look at the value style and you look at margins, they tend to mean revert because commodities tend to mean revert but.

Adam Parker

It's a small part of the market cap now, right, right.

Sébastien Page

And let me just also add to this argument. Not to completely freak out about valuations, the MSCI All Country World Index Equal Weighted, so average stock in the world, no market cap weighting, equal weighted. Its price/earnings ratio is 15 and its 30-year average is like 14. And so it's interesting. And as far as AI, an AI capex, I don't expect it to slow. I don't know if you expect it to slow, but we had a moment with DeepSeek that worried certain investors about the possibility that you could build these models for very cheap and that all this capex and energy infrastructure might not be necessary. And what happened? The hyperscalers said, ‘hold my beer.’ Let's go, right. And they're expected to continue to spend on capex at a rate of plus 80% for the next 12 months. That's right. So here we are.

Christina Noonan

One other area related to get your thoughts on, the circular deals taking place. Was it characteristic of the tech bubble? Do you think it's giving you pause or concerning that the company is making the chips, NVIDIA, now investing in companies like OpenAI, buying the chips?

Adam Parker

Yeah. I mean, I think if I look back at every prior bubble, there were two ingredients in place at each one: hubris and debt. Like, management arrogance gone awry and too much leverage. And there's some beginning signs of both of those two things forming. But, I don't think we're at some apex on the on the debt front. The circular lending is definitely an issue, right. I mean, you know, if you make an argument that OpenAI ultimately needs to do advertising to monetize stuff, then you have them using that to get that to get back, you're lending to Intel, to AMD, you know, the government.

Sébastien Page

Am I oversimplifying by saying that they're buying their own chip?

Adam Parker

No, I don't think. I don't think that's oversimplication. There's one or two arrows in the diagram between the two, but I think that's right. I think that's worrisome. I personally think we've a little bit said oh, the core businesses from the hyperscalers are so awesome and they generate so much free cash flow that it's not the same in this cycle. That's true.

But we're also starting to get a little bit of squishiness happening with pick loans in the data center and some other stuff. So I don't think we're at the debt issue yet where…But could you freak people out if Microsoft next week reports that they raised their capex to the point they have negative free cash flow, you might get people a little bit freaked out. Even the go-go growth folks on your committee, they might say well, wait a minute, I need Goldilocks on the hyperscaler capex. I need to go up a little to fuel the dream. But if it goes too much, I'm gonna be like, whoa, I didn't know Microsoft was gonna burn free cash when their core business is so awesome. So I think it's getting harder to fund.

My guess is it's still a year or two away from being more acute, especially with all the data center capex that's still in the works and planned. And then the hubris part like I don't know how you totally measure that, maybe it's billionaires that that Sébastien met in Palo Alto or whatever. But it's getting close. That stuff's getting a little more, a little bit harder to stomach.

Christina Noonan

Sticking with you, Adam. When do you think investors are going to start demanding more tangible evidence of applications and how companies are using this and you have a lot of great insights on how different sectors and industries you see this applying to, can you talk a little bit about that?

Adam Parker

2026.

We've been told from the beginning, because it's, if you think about it, and this is kind of an interesting anecdote. So in most firms, I think you alluded to it, you write your year ahead outlook in November for the following year. If you go back and look at the biggest firms, Goldman Sachs, JP Morgan, Morgan Stanley, and you read their year ahead outlooks in November 2022 for 2023, the economists and the strategist, six such documents. Goldman, Morgan Stanley, JP Morgan, strategy and economists, six documents. Guess how many times the words AI were used in November ‘22? The answer is zero. I'll spare you.

Okay, so in May ’23, we have the biggest upward sales of region of any mega-cap company ever with NVIDIA. So I'm just saying three years ago, nobody knew what AI was. Nobody thought it mattered for equity investing, for positioning, for cross-asset three years ago.

We were told there was three-to-four-year investment cycles. We're gonna start seeing productivity by ‘27 in a big way. So I'm going to answer your question. You know what? It's not Q1 ‘26, but it might be Q2 and it's certainly gonna be by Q3, like I need to see companies come in and say, you know what, here's a tangible reason why I can grow my revenue for a decade and no net hiring. Or I can see the incremental margin path that will get me excited. And the reason I focus on that is because look at Walmart and Costco, these are really low margin businesses, 3%, 4% net. When they go from 3% to 4%, it trades at 35 times earnings. Costco has gone from 2% to 3%, it traded to 50 times last year.

So when people see that net margin expansion on high revenue, they get excited. So what I've been doing is saying which comes in the stock market, have lots of employees, lots of revenue dollars, and low margin and just say, oh three of us are running business. What we do we would try to predict our employee behavior and our customer behavior and drive up costs. And so all of a sudden I'm attracted to these businesses where they could…McKesson is one, it's a 360 billion revenue, 1% net margin drug distributor. If they get better in anything, their margins go to 1.5% net. It's 50% raise growth. I'll pay 30 times for that, and so that it's just a microcosm. That's what you need next year.

Sébastien Page

You think AI efficiencies, that factor that gives them a margin boost from?

Adam Parker

I think it gets people seeing the proof cases of what they can replace people for where they won't have to net hire, where they can use attrition and replace them with cheaper, younger people. That kind of stuff. We haven't seen that yet. I mean, if you look at JP Morgan's earnings, they hired a lot of people. I mean, it's balanced balance sheet, everything is great. But I'm just saying, I would have thought a large number of employee companies would start ratcheting that back. And so I think I'm going to get frustrated if we're a year from now, If I get invited back, and we do this again, if we don't see any tangible proof cases from high employee count, high revenue businesses. But the short answer was 2026.

Christina Noonan

And I mean on that topic, how do you think this could impact the employment picture of the U.S.? You think that is too early to call or do you think it could have impacts?

Adam Parker

I was smiling when he said he used AI to figure out how many, of course, because I asked AI that same question. My bias as a former semiconductor analyst and also I would say in the older half of the cohort of investing world at this point was what this happens every cycle and talent gets redeployed to new areas and it's just people thinking like it's different this time. And sure, I could see the upside potential. So that was kind of my bias. And when I asked ChatGPT-5 it would agree with me.

But I am a little bit more worried about it than normal. You know, if you look at some of the Master’s degree hiring rates and undergrad hiring rates right now, they are a little bit weak and sort of kind of near previous cycles troughs. So it's a little worrisome, or troughs meaning like higher unemployment. So I'm a little worried about some 5- or 10-year lag as people redeploy their skills to get to other areas. And how in lots of professions, we know—whether it's asset management or research or law or banking—how you're going to get senior people if technology kind of replaces a lot of what they do and how do you marinate that to be kind of skilled senior people. I'm a little worried about that in the lens that I look at the world. But I think history shows people get redeployed to other areas and they end up doing fine. I think there's, if I had to bet, I think people are too negative about workforce redeployment.

Christina Noonan

Thanks, Adam. Great points on AI and some days that does feel like AI is the only theme driving markets and the only show in town and so it doesn't necessarily feel like it. But for U.S.-based investors, there have been other winners beyond AI. We have seen a broadening of markets so far this year, especially in international markets. The EAFE is actually outpacing the S&P by 10% or so, and small caps are actually ahead of large caps since Liberation Day, up 35%. Can you talk about some of the opportunities that we're seeing outside of the U.S. and beyond, Sébastien?

Sébastien Page

Yeah. Let me start with the international trade. Part of it has been U.S. dollar weakness and so if you tend to look at all your returns and U.S. dollar, international looks really, really good. It's been good. It's been even better because the U.S. dollar has been weak. I think I've told this story before in our webcast, but it's illustrative. If people will indulge me the story of a few months ago, when an analyst sent me a relative valuation dashboard and it was Russell 3000 Index, the U.S. stock market, compared to the All Country World Index ex-U.S. And I was looking at the measures and I noticed that outside the U.S., earnings growth was 2% higher, ROE was 5% higher, 20 versus 15, margins were 5% higher. Now this doesn't make any sense, right? There's a puzzle there for you. It doesn't make sense, like the fundamentals: earnings growth, ROE, and margins were better outside the U.S.

I thought it was wrong and I never yell at analysts, but I was gonna ask politely, why are you sending me wrong data. And it was technically correct, just a different lens. We guessed the puzzle here.

Adam Parker

You have too many profit lists. Small-cap companies in the U.S. in your comparable group.

Sébastien Page

Indirectly you get it and directly you get the answer. The dashboard was built on median data. So if you look at ROE outside the U.S. and you rank all the companies by ROE and you go right down the middle, you get a number that's higher than if you do the same in the U.S., right. So small- and mid-caps outside the U.S. have really good fundamentals in addition to cheap valuations and that thinking also applies to value outside the U.S.

Adam Parker

But the U.S. guy would say you just don't have anything awesome. You have lots of, like, your average is better, but you’re just missing all the awesome stuff. It's not totally true, but. I'm just kidding.

Sébastien Page

On a market cap-weighted basis, margins are much better, ROE is much better, earnings growth much better in the U.S.

Adam Parker

Right. Because tech is 4% of Europe and like you just don't have, you know what I mean, I mean it's just different – apples to -

Sébastien Page

But the point is, if especially if you have skilled active management in how you implement those building blocks, there's a world of opportunities. And at some point, you're right. Valuations have broadly not mattered for several years, but at some point when you have a relative valuation advantage plus accelerating earnings growth advantage plus some macro factors that are supportive, like dovish international central banks or increased defense and infrastructure spending and so on, you start to make the case for being long international, which the committee is.

So those are my thoughts on international. I'll say one thing for those quants in the audience, I don't know how many quants we have in our audience, but you have a very strong quantitative background, which by the way, I think is awesome for a strategist. One thing that quants know because it's been back-tested a lot is that valuations signals alone, there's a long history that show that over long periods of time they do work depending how you implement them. Here I'm talking about cross-asset, right international versus U.S. for example, they have not worked well recently, but they were okay over very long periods of time, but they work much better when the momentum signal agrees.

So what you're looking for is the intersection of something that's cheap and has positive momentum, or you want to short something that's super expensive and has negative momentum. Quant research has shown for years, and I published a paper in the general portfolio management about this recently with Buiatti, our colleague. The title is “When valuation fails,” and it just shows that when those two signals intersect, you're in a better shape and those two signals intersect right now for non-U.S.

Adam Parker

Yeah. I mean, I think people like the right equity call because I don't know anything about bonds. So like the right equity call has been non-U.S. value and you and U.S. growth and you almost couldn't screw that up with alpha if you just kept that North Star for the last five years. I mean, and I think the part that's less scary to continue with is the non-U.S. value than the U.S. growth. I think we're saying the same thing. I think you can own European banks, Japanese banks, other things. So I think they're growing and they're pretty still reasonably attractive on price intangible and you're not illustrating all the scary things that were potentially we know with 100% certainty that they're going to overbuild in data center like say, that's a probability of one that that will happen. I just don't know if it's 2030 and I care in 2028 in the stock market or ‘28 and ‘27, but I know that whereas I don't know why European banks can't be. So I don't mind, you know owning large cap, non-U.S. growth, I think that the comparable thing is time.

The U.S. growth bolus is so big by market cap that if I'm running money, I have to consider how much I wanna allocate that. I totally agree with the second part of the point which is I think I can generate more alpha and small cap securities than I can in large cap. There’s more anomalies. I probably should pay higher fees for somebody to do that for me. But and these are round numbers, I think the S&P is something like 15 to 16 times as big as the Russell 2000, $50-something trillion versus $3- or $4-trillion, round numbers. So if somebody says to me why like small caps more than large, that's not what he says. But if somebody says that, I say, OK, well, do you mean for every $16 million you're managing, you want to own 3 versus 13 instead of 1 of 15? I'm cool with that. You'll create some, an alpha. Maybe you'll get some of the cyclical upside and margins your time. OK, but if you say you want to own like 9 versus 7 more small cap, I disagree with that because I think the big companies are gonna grow etcetera, etcetera. So I think there's a construct there where I kind of want alpha in the small caps, but it's still pretty big core position in probably U.S. growth and non-U.S. value. At least that's my world.

Sébastien Page

NVIDIA is bigger than the Russell.

Adam Parker

Yeah, and yeah, and. And a lot of European countries, yeah.

Christina Noonan

And another trend that we're seeing deregulation, priority for the administration, have seen an uptick in M&A in recent months. Can you talk about what's unfolding in that space and how you're positioning for it?

Adam Parker

What I'm worried about is I have a view to be overweight financials and what I'm worried about are two things. Maybe three.

One is I think it's crowded. I think everyone agrees.

Two is that a lot of the large cap finances are very correlated to our AI semiconductors basket, including the M&A perceived M&A beneficiaries and the alternative asset managers. So if I look at like Trivariate’s AI semiconductor basket and I say which stocks not in tech are the highest correlated to it, and I look at the list, JP Morgan, Goldman Sachs, Morgan Stanley, KKR, Apollo, Ares, Blackstone. Like, they're all .8 or higher correlated to my basket. So one of the challenges, I think in the U.S. equity book right now is I think it's hard to find stuff that isn't super correlated to the AI trade. I think the way money gets run a lot is I bubble up my top idea and my financials expert, my industrials expert, says, oh, I like Eaton and Parker Hannifin and Emerson for electrification, and I like GE Vernova and Constellation and Vistra for power, and I like NVIDIA and Broadcom for semis and I like KKR and M&A beneficiaries, but they're all .85 correlated to the semis basket, so I worry about two things. Everyone loves it and it or you know, and it's correlated to semis.

But if I take the question and it's sort of at the where you started like, do I think regulatory and it's going to improve. I think so. It hasn't improved as much as I would have thought the night of the election. I think in certain areas, maybe consumer, you've seen a couple of deals, but I don't think when you talk to M&A experts and some of our clients are our corporations and law firms and boards of companies. We do a lot of work on management decision making. I would say they're not as excited as they were nine months ago, so it is a combo of like I think the trends your friend, I think it'll get a little bit better, but it's been less upside than it. Would have thought nine months ago

Christina Noonan

Let's shift to the macro picture, Sébastien. The narrative quickly shifted from tariff-induced inflation worries to now a softening job market and now even further complicated with the government shutdown and a lack of data. How are you thinking about this confluence of factors on in the economy and how the Fed will respond?

Sébastien Page

The first thing to worry about is the slowdown in hiring and the fact that now we are in a data blackout, so we don't know how much it's slowing down. But at the same time, pre-blackout, we saw that there were no firings either. The new claims data continued to hover around 230,000 and the long run average is 350,000, so very little firing. The other thing I'd like to say about unemployment is that we shouldn't focus too much on rates of changes. The unemployment level is 4.3%.

Long run historical average unemployment, Adam?

Adam Parker

5.7. Is that right?

Sébastien Page

Exactly. You got it on the dot.

Adam Parker

Six, I was lucky.

Sébastien Page

So 4.3 is actually it is, it's actually close to full employment at 4.3, so we have to put that into context and then when you start looking at real growth that's running, you know, based on the GDP trackers above, maybe 3.5%. An inflation that's probably still running at 3%, that's 6.5% nominal growth. That is more nominal growth than any calendar year between the great financial crisis and COVID. So I think you know the economy is doing is doing OK.

Christina Noonan

And you're saying strong nominal GDP growth and now with fiscal spending, how do you see that further perpetuating growth? I know our economist is bullish on growth going forward, do you think that's?

Sébastien Page

Adam says he always feels bad when someone asks are you worried about deficit. He doesn't want to say I'm not worried.

Adam Parker

Well, yeah, feel like a jerk. It might not age well.

Sébastien Page

So you ask it so, by the way, like one way to improve the debt-to-GDP ratio is to grow at 6.5% nominal when rates and debt coverage are sort of lower than that, right? So on the margin that helps.

There was a study on this on the relationship between that to GDP and subsequent growth by Reinhart and Rogoff. It's a very famous study. I've talked about it before. This was a paper that was published in 2010. And the punch line, before I go into the story of that study because it's interesting, is that really high debt-to-GDP ratios historically across a large panel of countries has not led to lower growth, which is kind of interesting. And you can quibble with methodology and so on. So let me tell you what the paper said and how the paper did it. They looked at a 90% threshold, so we're above that 90% threshold. So countries that had debt-to-GDP higher than 90%, they had a sample of 20 countries and they looked at data. It's a bit of an old paper from 1946 to 2009. So paper was published in 2010.

And they found that when countries had debt-to-GDP ratio of 90% or above, subsequent growth was -.1%. But the punchline to that story is that it became in the political sphere a very important paper, right, to stop spending. Many academics tried to replicate the methodology of Reinhart and Rogoff. And they couldn't replicate it. And it turns out they had an Excel error when they calculated the average growth for those 90% and above debt-to-GDP ratio, they left out—and this is alphabetical, was kind of interesting, right?—Austria, Australia, Canada and Denmark. And when you fix the data, the new result was 2.2% growth. Historically, 1946 to 2009 for countries with debt-to-GDP ratios of 90% and above. So a large swath of history shows that, yes, some countries can actually grow nominal GDP faster than debt service and so on.

So I'm just going to pause here and say I am not saying that deficits don't matter. They absolutely matter for the bond market, they matter for growth in different ways. But all I'm going to say is through this anecdote, the academic research is not actually super conclusive that just because you have a high debt-to-GDP ratio growth is going to crater.

Adam Parker

Or I've seen it manifest itself in the U.S. equity market is healthcare has been really a giant underperform for a couple of years. And I think it's because when people go down the logic of we're running at wartime deficit. If it ever gets corrected, they look at the biggest buckets of spending and they say, OK, well, eventually healthcare will be suppressed. So it's, there could be some stuff underneath the equity market where I, I feel like I've seen the markets near highs and it hasn't affected the S&P level, but underneath the surface, the deficit is definitely because I think people came to this year thing like RFK, Jr. is going to wreck the health care sector earnings OK or or whatever. And that was like a maybe a high-level psychology. But I definitely think it comes up in my meetings that if we ever get directionally austere, it'll come out of either defense or health care or both.

Christina Noonan

OK. So Adam, let's get your thoughts. So some investors are concerned about the deficit starting to shun Treasuries turning to assets like gold has been parabolic this year? Very unusual to see equity markets as moving as high and gold. Can you talk about that phenomenon and if this is a concerning signal to you?

Adam Parker

So I guess I'd back up and say I don't know. Meaning, like I haven't back-tested whether when those go. I think it's all because the Trump administration has said one of their stated goals, without using those words, is for the dollar to weaken. You've seen that, and Sébastien pointed out, when you look at the dollar returns and other countries versus the U.S., you seen it with the big movement, Bitcoin after the administration and all things related to mining and crypto. And then you've seen it with gold.

So I think they're all like this psychology of kind of dollar hedges and the like. The pure equity person in me would say like, yeah, I don't really get what these things are like. There's no cash. But to the extent, I think it's also become normalized and socialized in the financial advisor community that you can advise very wealthy people to own 5 or 10% in gold or Bitcoin and that they're kind of reasonable ways to play, so I think it's a combination of factors.

I actually think mostly it was China's demand and other things that caused it. But I think structurally people are giving advice now to own chunks of their portfolio in perceived, kind of, Fiat currency hedges and that's become more real. But I don't know if like your question was like. am I concerned that that's a signal like no. Like, everything went up so right, as we speak and as we're recording this, gold is having its worst day in a long time. So I just don't know how to time like, when that rotation will matter.

Sébastien Page

Gold going up that much with stocks is also unusual. It's kind of trading like a risk asset right now.

Adam Parker

Yeah, right. And so people would say, oh, well, this wealthy people win, like, whatever they own went up right or whatever. So I, you know, the quant part of means I haven't back-tested whether that correlation is a problem or subsequent return. My prior would be probably is a little bit how Sébastien set up the valuation argument, which is probably a volatility signal and not a directional one.

Christina Noonan

And staying on gold, we have an overweight position in real assets. So have benefited from the run-up in precious metals.

Adam Parker

Well, good call. Please please go on.

Christina Noonan

Predicated on inflation. But can you talk a little bit about how we're positioned in real assets and how we see that playing out?

Sébastien Page

We’ve benefited from that rally. Look, there's still inflation risk out there, not inflation risk that we go back to 9%, but inflation risk from the perspective that wages are still growing at 4% and that's hardly consistent with 2% inflation and 2% inflation target. Commodities are highly unpredictable. I kind of feel like you, like we have different jobs, different roles, but commodities are more of a question mark for an asset allocator, for many asset allocators, and right now oil is very low, looks closer to the bottom than the top. We have these rallies and precious metals. All I'm going to say is that commodities pose inflation risk because they've been incredibly well behaved. And then you have a housing shortage in the country that can create significant stickiness in shelter costs. And then you have tariffs, like some of those effects at least over a short period of time, they're going to raise prices, there's going to be some effect of tariffs. Some of our economists are looking at 100 basis points on CPI, as much as 100 basis points on CPI. And we haven't seen all of it.

So, so maybe lower effect, maybe we won't see as much as expected. But the point is you start lining up factors that can explain why we could still have inflation pressure.

Now we like to use real asset related equities as an inflation play because in the meantime, you're getting equity-like return or equity return. So it gives you an inflation reaction function that's very pronounced, historically. When you get an inflation surprise, those companies tend to do really well. But it also gives you a return push that you don't get from, say, just TIPS.

Christina Noonan

OK, Adam, so I want to come back to something you had touched on earlier. How everything is becoming correlated to the AI trade and I'm sure it's a question on a lot of our viewers and investors’ minds. Can you talk to us how you and your team, who have done a lot of work on this, are approaching risk management in the current environment?

Adam Parker

Yeah, I mean within one of the things we do at Trivariate is a lot of equity managers send us their portfolio and we do custom risk work. And starting about a year ago, we started seeing, you know, electrification and semis get correlated and obviously power constellation and then after the election we saw the financials get correlated. And so if you look at that AI basket, AI semis basket, we have it's not histrionic to say the S&P is basically an AI index at this point.

So I'm starting to say, OK, if I was 100% all in there, I'm starting to say which stocks are not in semis that are really correlated, let's sell some of those down. Some of the industrial, some of the power, some of the alternative asset managers and which stocks are up 10% or more in the last six months. So things are decent, but they have really low correlation to AI semis. So I'm finding Johnson & Johnson and McKesson Cardinal and Cora and O'Reilly and AutoZone and you know Lockheed Martin and just different things that aren't the exact same trade. So that I know. I'm not saying I go zero here I'm just starting to say I know in the next six months there could be some rotation. It could be high beta and highly correlated like it could be sharp and I just want to protect myself. Maybe I'll give up a little bit of the upside as we kind of continue on here to make sure that I'm not capturing all the downside when it does unfold. I just I think it's hard to not fade some of the rally the magnitude that we've seen but. But push back be, I could have said that a year ago and I would have been early, but I didn't. I'm just saying it now. I'm starting to worry about it and some of it's the speculative stuff that we've also seen, getting me a little nervous.

Christina Noonan

Maintaining diversification. Sébastien, any final thoughts as we get close to the end of today's webcast?

Sébastien Page

Ultimately, T. Rowe Price does not have house views. I say that often portfolio managers in equities and fixed income have full discretion. But from the perspective of the Asset Allocation Committee, we are neutral on risk assets. We're having massive debates on it, but we are neutral on risk assets, stocks versus bonds. We are short duration position for potential upside surprises in inflation and we are long diversification. We are long international value stocks; we just talked about long the real asset strategy.

And so I think that's a good way to play the current market. We're not taking large positions in the current environment. We're in a barbell. I hope I made the case at the beginning that when valuations are above 21, there's really a barbell of outcomes. So neutral and risk short duration, long diversification.

Last thing I will say, thank you, Adam. This was awesome. Really loved having you today.

Adam Parker

Yeah. Thanks for having me. My pleasure.

Christina Noonan

Thank you both. Great note to end on so. This concludes the fourth quarter's Asset Allocation Viewpoints webcast: “Balancing Act.” I want to extend a big thank you to our panelists. Thank you, Sébastien and Adam, and to you, our audience, for joining us today. Please access the same link found in your registration confirmation later this week for the replay with today's slides. Thanks again and we hope to see you again soon.

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Investment Risks

Active investing may have higher costs than passive investing and may underperform the broad market or passive peers with similar objectives. Each persons investing situation and circumstances differ. Investors should take all considerations into account before investing.

Technology companies: A fund that focuses its investments in specific industries or sectors is more susceptible to adverse developments affecting those industries and sectors than a more broadly diversified fund.

International investments can be riskier than U.S. investments due to the adverse effects of currency exchange rates, differences in market structure and liquidity, as well as specific country, regional, and economic developments. The risks of international investing are heightened for investments in emerging market and frontier market countries. Emerging and frontier market countries tend to have economic structures that are less diverse and mature, and political systems that are less stable, than those of developed market countries.

Commodities are subject to increased risks such as higher price volatility, geopolitical and other risks. Commodity prices can be subject to extreme volatility and significant price swings.

TIPS In periods of no or low inflation, other types of bonds, such as US Treasury Bonds, may perform better than Treasury Inflation Protected Securities (TIPS).Investing in technology stocks entails specific risks, including the potential for wide variations in performance and usually wide price swings, up and down. 

The value approach to investing carries the risk that the market will not recognize a security’s intrinsic value for a long time or that a stock judged to be undervalued may actually be appropriately priced.

Small-cap stocks have generally been more volatile in price than the large-cap stocks.

Because of the cyclical nature of natural resource companies, their stock prices and rates of earnings growth may follow an irregular path.

Fixed-income securities are subject to credit risk, liquidity risk, call risk, and interest-rate risk. As interest rates rise, bond prices generally fall. Short duration bonds have more risk than cash/cash equivalents such as money markets. Equities have higher risk and are subject to possible loss if principal.

Investments in high-yield bonds involve greater risk of price volatility, illiquidity, and default than higher-rated debt securities. Investments in bank loans may at times become difficult to value and highly illiquid; they are subject to credit risk such as nonpayment of principal or interest, and risks of bankruptcy and insolvency.

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Glossary of Terms

Alpha measures an investment’s performance against a benchmark index.

Barbell is an investment approach that seeks to allocate assets between high-risk and low-risk assets.

A basis point is equal to 0.01% or 0.0001. It is used to describe changes in percentages or interest rates.

A bear is an investor who believes the price of an asset or the market will decline; a bearish market is one where prices are generally expected to fall.

Book value of a company is assets minus liabilities.

A bull is an investor who believes the price of an asset or the market will increase; a bullish market is one where prices are generally expected to rise.

CAPE (cyclically adjusted price-to-earnings ratio), or the Shiller P/E, adjusts past earnings for inflation over a decade.

Capex (capital expenditure) refers to a company’s spending in long-term assets such as property, technology, or equipment.

Central banks are financial institutions that manage the monetary system of a nation or group of nations; The Fed (the Federal Reserve) is the central bank of the United States.

Consumer Price Index (CPI) measures the monthly average change in prices paid by urban consumers for a market basket of consumer goods and services.

Dividend yield compares dividend per share against price per share. It measures how much a company pays in dividends relative to its stock price.

A hyperscaler is a company, often a technology or cloud services provider, that operates cloud infrastructure platforms.

Gross Domestic Product (GDP) is the total value of goods and services produced by a country’s economy.

The MSCI ACWI Index is an index that covers approximately 85% of the global investable equity opportunity set across developed markets and emerging markets countries.

Purchasing Manager’s Index (PMI) is an economic indicator used to measure the direction of economic trends in manufacturing and services sectors.

Price-to-Book (P/B) ratio measures divides a company’s current share price by book value per share.

Price-to-Earnings (P/E) ratio measures a company's current share price relative to per-share earnings.

Price-to-Sales (P/S) ratio compares a company’s stock price to revenue.

Return on Equity (ROE) is a financial measurement that divides net income by shareholder equity.

The Russell 2000 Index measures the performance of the small-cap segment of the U.S. equity universe and includes approximately 2,000 of the smallest securities, based on a market cap and current index membership.

The Standard & Poor’s 500 Index (S&P 500) tracks the stock performance of 500 of the largest companies listed on stock exchanges in the United States.

Treasury Inflation-Protected Securities (TIPS) are a type of treasury security where the principal value is indexed to inflation.

Please also refer to troweprice.com/glossary for additional terms.