Bank of America says these 3 higher-risk stocks are well-positioned to take off as rate cuts spur an economic recovery in 2025

In times of economic uncertainty, investors tend to run away from risk.

But despite warning signs emerging in the labor market, Bank of America says investors should start to consider adding riskier assets to their portfolio heading into 2025.

While the economy is in a downturn phase right now based on Bank of America’s Regime Indicator, the economy could start improving by as early as the first half of 2025, the bank said in a recent note from a team of analysts led by Justin Post. That’s thanks to the Federal Reserve kicking off a rate-cutting cycle and other encouraging economic indicators, like improving GDP forecasts and earnings estimates, as well as falling high-yield credit spreads.

This in mind, investors may want to consider putting money into value, small-cap, and higher-risk assets heading into 2025, as these factors typically outperform in the recovery phase of the economic cycle, the bank said.

From downturn to recovery

One of the main reasons the bank sees a risk-on outlook in the market taking hold early next year is rate cuts.

The stock market breathed a sigh of relief when the Fed finally initiated an easing cycle with last week’s 50 basis point rate cut, with the S&P 500 rising 1.78% in the two days following the policy adjustment. Bank of America is expecting another 75 basis points of cuts in Q4 2024 and 125 basis points spread out over the course of 2025, bringing the terminal rate to 2.75-3.0% by the end of next year.

But for the time being, the economy is still in the Regime Indicator’s “downturn” phase.

During downturn periods, investors usually flock to quality, large-cap, and low-risk companies. While Bank of America believes investors should stay in defensive, high-quality areas to weather a potential economic downturn, they should also be forward-looking in anticipation of improving conditions within the next few months by keeping their eye on value, small-cap, and higher-risk stocks.

After screening for market cap and valuation — as smaller and cheaper companies tend to outperforml in an economic recovery — the analysts controlled for riskiness by looking at stocks with higher beta levels — or a stock’s relative volatility compared to the rest of the market. For example, an index like the S&P 500 has a beta of 1.0, and each individual stock’s beta is compared against the rest of the market. A stock with a beta above 1.0 tends to move more than the market and vice versa.

That means that while higher-risk stocks might drop more dramatically than the S&P 500 during a downturn, it has the potential to appreciate faster than the rest of the market during a recovery.

The screen of the three variables produced a list of a few dozen stocks, but only three were buy-rated by Bank of America analysts. They are listed below, along with their betas.