It’s been a strong year for stocks, and the best may be yet to come.
With just one trading day left in 2024, the S&P 500 is up nearly 23%. However, when investors look back at the past year, they will see a textbook example of why the stock market has been a poor proxy for the economy, which has provided unclear and, in some cases, conflicting data points.
For example, many indicators indicate that the US economy is in good shape. Consumer spending is stable, unemployment is low, the inflation rate is down from its 2022 highs, and the Federal Reserve has begun cutting interest rates.
On the other hand, oil and gasoline prices behave as if there is little demand. Gold and Bitcoin rise as if a major economic crisis is approaching. The average wage for American workers is $43,222.81, which is only about $12,000 higher than the poverty level for a family of four.
Despite this, with few exceptions, putting money in the market has given investors the chance to make the strongest return – and analysts are predicting an even better year in 2025.
Why was 2024 a great year for stocks?
The simplest explanation for strong market performance in 2024 is earnings growth. Early in 2022, companies began eliminating payrolls and taking other cost-cutting measures to impact their bottom line. These movements will accelerate in 2024.
However, to the frustration of many buy-and-hold investors, the strongest gains were limited to a few stocks in a few sectors. Artificial intelligence (AI) stocks have performed well. Much of the attention has been focused on companies that provide critical hardware for AI infrastructure, such as NVIDIA Corp. (NASDAQ: NVDA). But as the year comes to a close, investors are looking to stocks like Palantir Technologies Inc. (NYSE: PLTR) and SoundHound AI Inc. (NASDAQ:SOUN) as the future of artificial intelligence.
But AI stocks weren’t the only ones seeing gains. The GLP-1 craze has lifted shares of biopharma companies like Novo Nordisk A/S (NYSE: NVO) and Eli Lilly & Co. (NYSE: LLY). Companies in other sectors have outperformed the S&P 500, including blue-chip names like Walmart Inc. (NYSE: WMT), JPMorgan Chase & Co. (NYSE: JPM), and American Express Company (NYSE: AXP).
In every sector, profits separated the winners from the losers. Companies that have shown they can deliver strong earnings and/or increase their guidance have been rewarded – perhaps excessively. Conversely, companies that failed to achieve profits and/or lowered their guidance were penalized, perhaps excessively as well.
Why 2025 might be better for stock investors?
The main reason to believe that 2025 could be a great year for stocks is simply based on probability. Since 1926, the S&P 500 has delivered a positive return 73% of the time. During the same period, the index delivered a double-digit return 60% of the time.
The mathematics supports macroeconomic conditions. The last time the S&P 500 had a negative return was in 2022. At that time, inflation was at its highest levels in 40 years, and the Federal Reserve was beginning its campaign to raise interest rates. Heading into 2025, inflation remains steady but much lower than in 2022, and interest rates move lower and higher.
Then there is something known as “animal instincts,” which are the emotional and psychological factors that influence consumer and investor behavior, which often lead to changes in economic activity. There has been a tangible shift in investor sentiment since the US presidential election, and there are many reasons why investors are confident that this enthusiasm will continue into 2025.
First of all, one of the next administration’s business items will be to make the 2017 tax cuts (i.e. the Trump tax cuts) permanent. The president-elect also pledged to reduce the corporate tax rate from its current level of 21% (already the lowest since 1939) to 15% for companies that manufacture their products in the United States.
But there is a lot more for investors to consider. In addition to cutting taxes, the incoming Trump administration wants to reduce regulations related to energy production, financial services, health care, and environmental protection. Investors are already seeing evidence that this could spur mergers and acquisitions activity, which has slowed to a crawl under greater antitrust scrutiny.
Then there is the Government Efficiency Administration, a proposed initiative aimed at identifying and eliminating wasteful government spending, streamlining bureaucratic processes, and improving the cost-effectiveness of federal programs. It’s certainly unexpected, but even if the initiative achieves only a small part of its goal, it will benefit the broader economy. This is because less government spending would do much of the Fed’s job in terms of lowering the inflation rate to its preferred target of 2%.
On the demand side, the Fed said it would not cut interest rates as much as it initially expected. However, the trend will remain for at least a few interest rate cuts throughout the year, which should keep consumer spending afloat.
Where to invest in 2025?
Of course, believing that the market will move higher is one thing; Making decisions about where to put that money is another matter. Here are some sectors to consider:
technology
Not surprisingly, technology trading will remain active in the new year. AI will continue to be a hot topic, but so will semiconductors. Investors may want to pay attention to software stocks, as the company’s ability to monetize AI will be a key driver of profitability.
Industries
Despite efforts to reduce government spending, much of the money from the Infrastructure Act is contractually obligated through 2026. This means companies in this sector will still be solid investments.
energy
The Trump administration has made US energy independence a priority, and that bodes well for oil and gas stocks.
Facilities
Demand for data centers and building AI infrastructure are just two reasons to believe electricity and natural gas stocks will be among the winners.
Investors should expect volatility
Markets do not move in one direction all the time. With many stocks at high valuations, a pullback in the first quarter of 2025 is not only likely, but would be welcomed by many investors who want to acquire some of their favorite stocks at more attractive prices.
Beyond valuation concerns, there are other unknowns heading into 2025. For starters, it is not clear how wide and impactful Trump’s tariff policies will be. Although the downside is overstated, it is safe to say that the battle to control inflation is far from over.
The new year also brings geopolitical uncertainty. How the Trump administration handles the Russia-Ukraine war and how successful it is in calming tensions in the Middle East and China will be crucial to calming markets.
With all that said, volatility is normal. Investors should take this advice Time in the market Better than Trying to time the market. The trend is that stocks are moving up. Don’t fight this trend.
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