The Best Two Years in a Quarter Century for Stocks

U.S. stocks delivered an impressive performance in 2024, marking a standout year for investors. However, expectations for 2025 are more tempered, as the market faces potential headwinds and challenges.

‍

The S&P 500 surged by 23% during the year, achieving 57 record closes, supported by a strong economy, easing inflation, and the ongoing artificial intelligence (AI) boom that bolstered major technology stocks. Despite some weakness in the final trading days, the index recorded its best consecutive years since 1997 and 1998, a period that preceded the dot-com bubble burst.

‍

This remarkable rally has created wealth for investors and fueled optimism among professionals. According to a December Bank of America Global Fund Manager Survey, enthusiasm for U.S. equities reached record levels. The positive momentum extended beyond stocks, with gold experiencing its strongest year since 2010 and bitcoin more than doubling, briefly surpassing $100,000 before retreating below that level.

‍

Looking ahead, many investors are cautiously optimistic that a robust U.S. economy and a Federal Reserve shifting toward rate cuts—albeit not as aggressively as some had hoped—could sustain gains in the stock market. Still, few believe the rapid advances of the past two years will be repeated in 2025.

‍

One major concern is the potential for interest rates to remain elevated, which could increase borrowing costs and provide investors with lower-risk alternatives to equities. The Federal Reserve has signaled uncertainty about further rate cuts, and benchmark Treasury yields were already climbing before these statements. Higher interest rates could pose challenges to the stock market’s upward trajectory.

‍

Another factor is the increasing valuation of stocks. The S&P 500 traded at 21.9 times its projected earnings over the next 12 months, compared to a 10-year average of 18.5 times, according to FactSet. While some argue that the dominance of high-growth technology companies justifies these elevated valuations, others remain concerned about the market's lofty price levels. Elevated valuations could limit long-term returns and place greater importance on corporate earnings growth to sustain performance.

‍

“The market has sort of topped out in terms of multiple and can really only grow through earnings,” said Brad Conger, chief investment officer at Hirtle Callaghan & Co. “It puts a high burden on companies to actually deliver.”

‍

Analysts predict S&P 500 companies will grow earnings by 15% in 2025, compared to an estimated 9.5% growth for 2024. This high bar could pressure companies, with traders quick to penalize underperformance. For example, Adobe shares fell 14% in a single day after the company issued weak sales guidance.

‍

AI investments remain a focal point for investors, but questions persist about when these expenditures will translate into profits. Companies like Alphabet and Amazon faced scrutiny for significant spending paired with signs of slowing revenue growth. Still, major tech stocks continued to drive the market. Through December 24, the so-called "Magnificent Seven" stocks—Alphabet, Amazon, Apple, Meta Platforms, Microsoft, Nvidia, and Tesla—accounted for over 53% of the S&P 500's total return, with Nvidia alone contributing 21%.

‍

Beyond technology, other sectors also contributed to the rally. Financial stocks gained 28% in 2024, while utilities and industrials rose 20% and 16%, respectively. Many investors believe the market will broaden in 2025, with opportunities in sectors outside big tech. Holly MacDonald, chief investment officer at Bessemer Trust, noted that stocks in industries like industrials, utilities, and healthcare offer more attractive valuations. While Bessemer has reduced its exposure to technology stocks, it remains optimistic about other segments of the market.

‍

Small-cap stocks have also drawn attention after underperforming large caps in recent years. The Russell 2000 index remains nearly 9% below its record high from late 2021, even as the S&P 500 has climbed 25% since then. Analysts expect small-cap stocks to benefit from the Federal Reserve’s rate cuts, as these companies often rely more heavily on floating-rate debt, which becomes cheaper as rates decline.

‍

Despite these opportunities, risks remain. The Federal Reserve surprised markets in December by signaling a slower pace of rate cuts than expected, leading to a sharp sell-off. The Russell 2000 dropped 4.4% in its worst day in two-and-a-half years, while the Dow Jones Industrial Average fell over 1,100 points, marking its longest losing streak since 1974. Additionally, the yield on the 10-year U.S. Treasury note has risen, reaching 4.577% from 3.860% at the start of the year, further complicating the outlook for equities.

‍

Political uncertainty also looms. Stocks rallied following Republican victories in the November elections, as investors anticipated tax cuts and reduced regulation. However, President-elect Donald Trump’s proposals, including tariffs and mass deportations, could introduce inflationary pressures and disrupt markets.

‍

“What happens to all this excitement when we start to get all the details?” said Anna Rathbun, chief investment officer at CBIZ Investment Advisory Services. “We don’t know what the tariffs are going to look like. We don’t know what deregulation is going to look like.”

‍

Given these uncertainties, many expect a more volatile market in 2025. While the economic backdrop and Federal Reserve policies could support further gains, the challenges of elevated valuations, high expectations for earnings, and political risks suggest that the path forward may be less straightforward than the blockbuster years of 2023 and 2024.

‍