2024 was a strong year for the stock market as the S&P 500 had a price return of 23.3% (source: Morningstar). Much of the year saw returns dominated by large technology companies as enthusiasm around artificial intelligence fueled earnings growth. Returns broadened out during much of the 2nd half of the year as financials, utilities, and small caps each took turns as market leaders. Despite the positive year, 57 stocks in the S&P 500 finished down more than 20% in 2024 according to data from MarketWatch, highlighting the need for a prudent stock selection process. Entering 2025, our indicators suggest the market is on healthy footing, and that the secular bull market still has years left to run. However, evidence suggests that 2025 will see more volatility and lower returns than the prior two years.
The US is still in a positive demographic cycle with their largest generation, Millennials, early in their peak spending years. This has been strongly correlated to long term market performance in the past. Market breadth indicators confirmed the market highs in December, and credit markets remain healthy. Capital expenditures on artificial intelligence capabilities continue to drive earnings for technology companies (about 1/3rd of the stock market) and the resulting productivity gains drive earnings for non-tech companies. Both corporate and consumer balances sheets are healthy in aggregate.
However, we do see reasons to temper one’s optimism. Valuations for large cap stocks are at multi-year highs, and analysts expect earnings to grow 14.8% in 2025 according to Factset. It is likely that much of that earnings growth has already been discounted by 2024’s gains; high valuations and high expectations make it difficult for the market to exceed expectations going forward. Returns over the past 2 years have reached levels that have historically led to a pause in the market. There was no 10% decline in 2024; consecutive years without 10% pullbacks are historically rare, and the average intra-year decline in the market has been 14.1% since 1980 according to JP Morgan. Meanwhile, tariff policy, interest rate policy, and geopolitical turmoil are pertinent risks to the stock market. History suggests one of those risks is likely to materialize this year and spook the market. Investors should prepare emotionally for a more volatile year.
In summary, 2025 is likely to offer a bumpier ride than 2023 and 2024. We remind clients that volatility is the emotional price investors pay for higher returns over the long run. We urge clients not to be deterred by short-term risks as the long-term trends remains strong. As always, our process will seek to adapt to changing conditions and tilt accounts towards areas of strength in the market.
