The coming year promises to be interesting for investors. In the US, a business-friendly government, lower interest rates and possible corporate tax cuts could support earnings growth. But the high valuations have many investors on edge. Let’s see what experts say about these competitive dynamics and their impact on different parts of the stock market in 2025.
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The S&P 500 (^GSPC) should deliver modest returns through 2025, with some volatility going forward. Marta Norton, chief investment strategist at pension provider Empower, expects large caps to benefit from improving macroeconomic conditions and continued adoption of artificial intelligence.
Norton calls appreciation an ‘important countervailing force’. Valuation in this context refers to stock prices relative to earnings and other business fundamentals. When valuations are high, investors pay more for profits – usually in expectation of strong growth. If growth is disappointing, volatility may arise.
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Small- and mid-cap stocks may outperform the S&P 500 in 2025. The driving force will be the outsized benefits that smaller companies should experience from lower interest rates and potential corporate tax cuts.
According to David Rosenstrock, director at Wharton Wealth Planning, small- and mid-caps are more likely to rely heavily on variable-rate debt, while larger companies prefer fixed-rate facilities. Variable rate borrowers benefit immediately from interest rate cuts as their obligations are quickly reset. Existing fixed-rate debt does not adjust to the lower interest rates until it is refinanced.
Tax cuts could benefit small- and mid-caps because most of their revenues tend to be earned in the US. Rosenstrock explains, “Reducing the corporate tax rate could provide greater relief for these asset classes than for large caps, whose geographic revenue sources are more diversified.”
Growth stocks may underperform in 2025. Crit Thomas, global market strategist at Touchstone Investments, cites high valuations and slower earnings growth as factors to watch. “These stocks may need to take a pause so that earnings can catch up with valuations,” Thomas said.
In addition, investors in growth indices should be wary of concentration risk. As Thomas notes, “The top five stocks in the Russell 1000 Growth Index comprise 45% of the market cap.” When just a handful of stocks drive the group’s performance, volatility can result.
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Value stocks are expected to outperform in 2025. Value stocks are characterized by slow and steady growth and low valuation ratios. Many pay dividends and generate strong and increasing cash flows.
Value stocks have largely underperformed their growth-oriented counterparts over the past decade. The year 2022 was the exception. James Lebenthal, partner and chief equity strategist at wealth advisor Cerity Partners, expects value stocks to shine again in 2025. “Their earnings growth will accelerate while their stock prices have languished for most of the last decade,” Lebenthal said.
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