5 investing themes for 2025

Stock investors have enjoyed a powerful rally over the past 2-plus years, with the S&P 500^® Index gaining 67% between September 2022 and November 12, 2024. I analyze past trends to uncover insights for today's investors. I recently examined whether the ongoing stock advance is likely to be durable, given the coming year's economic and political uncertainties. My analysis suggests the answer is yes, especially for cyclical stocks.

Seeking clarity in the economy and stock market

The outlook for the coming months appears cloudy. The election is behind us, but it remains to be seen how much the new administration and Congress will accomplish, whether interest rates and inflation will rise or fall, what geopolitical risks may arise, and how the economy will fare. Small-business owners say uncertainty is at its highest level ever, according to the National Federation of Independent Business (NFIB) Small-Business Uncertainty Index.

Notably, small businesses typically compose more than 40% of the US economy and more than half of the net new jobs.

When uncertainty has soared, stocks have followed

It may seem prudent to wait for clarity before investing, but history suggests otherwise. Historically, high uncertainty typically has been followed by strong stock returns. When the NFIB Uncertainty Index has reached the top 5% of its range since 1974, the market has returned an average of 22% over the next 12 months. One possible explanation: Investors worrying about potential headwinds may overlook major tailwinds.

Low rates and oil prices may put the wind at investors' backs

Both oil prices and the interest rate on 10-year Treasury notes dropped during the 6- and 12-month periods through August. In the past, simultaneous declines in oil prices and rates have boosted subsequent stock returns. Since 1980, when both 10-year rates and oil prices fell 15% or more, as they did for the 12 months through August, the S&P 500 returned an average of 18.9% over the next 12 months—even though oil and rates have tended to bounce back after big declines.

Cyclical stocks may outperform

Cyclical stocks—a group that's generally considered to include communication services, consumer discretionary, energy, financials, industrials, materials, real estate, and technology—have been the biggest beneficiaries when interest rates and oil prices have fallen together.

The combined percentage decline in one-year Treasury yields and crude prices is in the top decile since 1962. When these 2 key costs fell this far in the past, cyclical sectors tended to outperform the broad market, while defensive stocks typically underperformed. Real estate has been the top-performing sector during these periods, and utilities has been the laggard.

My 5 themes for 2025

Based on this analysis and my other research, I have identified 5 themes I think could benefit asset allocators in 2025.

1. Stocks over bonds

Several factors point to stock market strength in the coming year. Oil prices and interest rates have fallen simultaneously, as noted above. Valuation spreads—the gap between the valuations of the market's most- and least-expensive stocks—are high. And the bond market has been more volatile than the stock market for the most recent 12-month period. All 3 of these trends historically have been bullish for stocks, particularly relative to bonds.

2. Overweight financials

Financials have outperformed in 2024, so they're not as cheap as they were at the beginning of the year. Still, the sector's valuation has remained in the bottom quartile of its historical range.¹ Since 1962, the sector has outperformed from comparable levels in the past, beating the market by an average of 500 basis points over 12-month periods following bottom-quartile valuations.² Meanwhile, valuation spreads in the sector are at top-quartile levels. Since 1990, financials have had 68% odds of outperforming the market over the 12 months after top-quartile valuation spreads, with average outperformance of nearly 800 basis points.³

3. Overweight consumer discretionary

Consumer discretionary stocks started the year relatively expensive based on price to free cash flow (P/FCF). Valuations decreased in 2024, however, with P/FCF relative to the market falling to the bottom quartile of its historical range. From similar levels since 1980, the sector has had 70% odds of outperforming the broad market over the following year, with average outperformance of 800 basis points.⁴ Also, consumer discretionary stocks' earnings grew faster than the market over the last 12 months.⁵ The combination of low valuations and market-beating earnings growth has been rare and powerful for the sector.

4. Be cautious of utilities

Defensive sectors have underperformed in the past after the combination of falling interest rates and crude prices. Utilities especially struggled, producing 12-month returns that trailed the market by double digits, on average, since 1962.⁶ Another potentially negative sign for the sector: Yields on 10-year Treasurys have risen even as the Federal Reserve has cut interest rates. This combination is relatively uncommon; after it has happened in the past, utilities have outperformed the market only 9% of the time since 1962.⁷

5. Consider mid-caps

Mid-cap stocks have looked cheap based on book value and earnings. Since 1990, the cheaper they've been, the more likely they have been to top the performance of large caps over the following 12 months.⁸ At the same time, mid-cap earnings have accelerated, rising from negative levels last year to 5% this year, with analysts projecting stronger growth in 2025—another historically bullish signal.

Conclusion

Based on history, investors may not want to wait in the wings until uncertainty resolves. Stocks could continue to gain, and cyclical sectors could outperform more defensive sectors.