Happy New Year, and welcome to 2025! 2024 was a good year for the market, with the S&P 500 bringing in back-to-back double-digit returns. After seeing a 26% return in 2023, the S&P 500 ended 2024 up 25%. International and Emerging markets struggled to keep up with the U.S., but the MSCI Total World Index still ended the year up 19%. In Fixed Income, the Bloomberg U.S. Aggregate was up 1.3% for the year, with the yield curve still inverted, favoring shorter duration bonds*.
Looking back at our commentary this time last year, it seems that higher than normal equity valuations, inflation, elections, the increasing cost of debt, and the Federal Reserve’s interest rate moves did not stall the market. Returns did begin to broaden from the “Magnificent Seven”, the dollar did not weaken in 2024, and International Developed stocks continued to lag the U.S., despite their more attractive valuations.
MARKET CONCENTRATION AND AI
Predictably, 2025 comes with uncertainties of its own. U.S. stock valuations remain elevated, and indexes are becoming more concentrated. U.S. equities now make up a significant portion of global indexes, over 65% in some cases. Inside the S&P 500, a U.S. Large Cap standard, the 10 largest stocks make up nearly 39% of the index1. It’s crucial to point out that concentration amplifies outcomes: one or two of those stocks can have a significant impact on total performance. So far, that impact has been positive, but do not forget a downturn can be just as substantial.
Advances in AI, what some are calling “mega forces” in the market, are fueling the performance of those “Magnificent Seven” stocks. While companies continue to pour significant resources into AI, the question for shareholders is when it will shift into profits. Considering some experts are comparing AI’s potential market disruption to that of the invention and proliferation of the internet, it holds considerable promise. Sam Altman said recently, “We believe that, in 2025, we may see the first AI agents ‘join the workforce’ and materially change the output of companies2. We’re already seeing Microsoft, Google, and Apple talking about and integrating AI into their systems. It’s possible the change may come sooner than imagined, and while these large companies continue to spend on AI, they all have plenty of cash available to do so. While historically “mega forces” have been volatile, underestimating these trends is risky. The impact and concentration of the “Magnificent Seven” may become a long-term trend as AI becomes more prevalent.
Higher market concentration typically results in higher volatility. The past few years of positive markets and minimal drawdowns have lowered our tolerance for volatility. It’s not uncommon to see 5% up or down days in equity markets, but that hasn’t been the case recently. With concentration increasing, it won’t be surprising if we see volatility resurfacing this year. A properly diversified, actively managed portfolio has proven to be a reliable hedge against concentration risk and volatility.
INFLATION
Inflation remains a concern in 2025, exacerbated by threats of tariffs from the incoming Trump administration. While inflation appears to be normalizing, it’s still too early to call the soft landing a success. The Fed lowered the federal funds rate to the 4.25%–4.5% range after three rate cuts in September, November, and December. The November core consumer price index rose 3.3% from a year earlier. Historically, inflation has come in waves, and it remains to be seen if the Fed can hold off a second wave in 2025 or 2026.
This time last year we said it’s difficult to argue against the bull market. Looking into 2025, that remains the consensus. U.S. markets remain strong, and earnings continue to come in at or above expectations. Inflation has moved in the right direction so far, and the job market is still solid. Consumers continue to spend despite a negative sentiment around inflation. Capital expenditures continue to grow as business confidence has been buoyed by the incoming presidential administration. Mergers and acquisitions have the potential to grow with less restrictive regulation, and the divergence in growth and inflation data between the U.S. and International Markets may be intensified by policy changes.
THE IMPORTANCE OF ACTIVE MANAGEMENT
We believe that active management will play a more pivotal role in 2025 as performance continues to broaden from the largest names in the indexes. Diversification is crucial and being aware of where concentration risks lie should be an essential part of portfolio management. In 2024, most investors in index funds outperformed active managers in similar spaces. It’s why we moved in line with benchmark weightings and continue to hold that position moving into 2025. However, as a new administration takes over in the U.S. and performance continues to broaden from the “Magnificent Seven”, we believe active managers in targeted areas of the market will have opportunities to enhance performance.
Regardless of what 2025 may bring, having an investment plan that is aligned with your personal goals and risk tolerance should always be the foundation on which any portfolio is built. We hope you’ll reach out in 2025 if SIMA can help you build or adjust your plans. Feel free to give us a call at (804) 285-5700 or send us a message at wealth@simafg.com.
*Individual returns will vary based on percentage allocated to equity, fixed income, and cash
1: Source: YCharts – Financial Research and Proposal Platform
2: Source: OpenAI CEO Sam Altman says AI agents will enter workforce this year
Heather A. Voight, AIF® | Portfolio Manager
Previous Market Commentaries
2024 First Quarter Market Commentary
2023 Third Quarter Market Commentary
2023 Second Quarter Market Commentary
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