Market Forecasts, Mega Stocks, and the Year Ahead

January 25, 2025  | By Kevin Smith

The image below reflects what I imagine the world’s greatest stock market forecaster envisions when she closes her eyes. All of the millions of variables perfectly connected into a beautiful coherent understanding of how it all works:

Imagine a formula that compiles all of these variables into an accurate prediction about the stock market: tariffs, Federal Reserve interest rate changes, de-globalization, BIG A.I., disruptive A.I., D.O.G.E, immigration, Middle East conflict, energy policy, EuroZone challenges, China!?!?, Canada?, Bitcoin, Russia-Ukraine, rise of the robots.

And those are the just the headline topics!

Not having achieved that state of nirvana and not knowing who has, we will proceed talking about market forecasts with a healthy dose of humility:

• Market prices are in constant motion (except for Private Equity, but I’ll save that for another article). Most price movements appear random and move within a range.
• We always prefer to own more high quality assets that are on sale and fewer low quality assets that are expensive. Our strategies are designed around that concept, and they seek to benefit from buying low and selling high as prices bounce around. That is standard daily business.
• We are extra interested when there are extreme conditions in markets. When prices are historically cheap, historically expensive or just historically strange. Those conditions can impact our expectations and our investment decisions.

What will the market do this year?

This is the most common question in January. My answer: probably somewhere between down -25% and up +40%.

My forecast is based on the nearly 100 years of S&P 500 returns data, looking at all of the 12 month periods and stacking them based on their frequency. I would have been right 90% of the time using this model, so I feel pretty good about it. This is what I meant by a normal range of prices:

Source: IFA.com

How did investments do recently?

The dismal market performance of 2022 now feel like a distant memory. Nearly every major asset category performed poorly (with the exception of managed futures… shout out!) The last two years have been a strong rebound, but there’s a catch:

It isn’t fair or rational to compare the United States economy without including the biggest, most dominant companies: Apple, Google, Amazon, Meta, Microsoft, Nvidia, and Tesla. They wield enormous influence over our lives.

However, it is important to recognize they have been the primary drivers of U.S. stock market outperformance over the past two years.

Can the Mag 7 keep it up in 2025?

I wouldn’t be surprised in the near term, but disruption is inevitable.

The price of admission to the Mag 7 party is getting steep. The earnings of most of these companies have been extraordinary recently, which understandably pushed the price up. However, the price paid for each dollar of earnings has inflated.

This is expressed in the P/E Ratio. A high ratio indicates investors are paying a premium. If that premium collapses, prices can fall dramatically even if the underlying performance of the company remains strong.

Mag 7 prices could be considered extreme, but some more than others. The plot thickens. It’s not just a group of exciting tech stocks that are expensive, it’s that all expensive stocks across all industries are historically expensive, on average. The chart below shows the difference in PE ratios between the most expensive (quintile) and least expensive. The gap is enormous:

The U.S. market is not the only market

Meanwhile, in the rest of the world, stocks look relatively undervalued! Last time international developed and emerging markets were this inexpensive — back in the late ’90s — they went on to outperform the U.S. stock market over the following decade.

The conditions are even more extreme now:

What about cash and bonds?

I like to joke that bonds are boring and complicated. These days they are extra boring.

In most economic conditions, investors are rewarded for loaning their money for long periods of time by receiving higher interest rates on their payments. Right now you get about 4.5% on loans from savings accounts to loans of 30 years!

The yield curve displays interest rates paid for loans from short to long periods of time. The yield curve is more like a ‘yield line’. It is almost flat:

Short Term Bonds (less than 3 years)

The great news is you earn a meaningful return on your cash and low risk bonds. The downside is when interest rates fall you quickly begin earning less interest. These investments remain suitable for expected withdrawal needs within the next three years.

Intermediate Term Bonds (3-7 years)

Because there isn’t any extra interest earned from these bonds in the current market, an argument could be made to hold Short Term Bonds instead. The potential benefit of Intermediate Bonds is the ability to continue receiving the same interest rate if interest rates on newly issued bonds fall, with the added benefit of their value increasing at the same time.

Long Term Bonds (7+ years)

If interest rates rise, these bonds will be severely negatively impacted. This is what led to bank failures in 2022. These don’t make sense for most investors unless you are trying to match a debt obligation with a certain amount of funds to be available when it is due in the future. If you are holding that bond to maturity, you may not be bothered my changes in interest rates.

Bond prices aren’t currently extreme like some stock prices, but they are unusual.

What This Means for Your Investments

Much of what we’re seeing today—overpriced U.S. stocks, undervalued international markets, and an odd bond yield curve—was also true a year ago. Our Fundamental Portfolio strategy is built to capitalize on extreme market conditions as they normalize over time. No major shifts are needed, but as always, we’ll continue to fine-tune your portfolio in alignment with your financial goals.

If you have questions or want to discuss your strategy, we’re here to help.