It is going to be a tougher task to find the sort of performance that has come through in the US equity market in 2024, argues the author of this article.

The following article reflects on what 2025 may hold for US equity markets – a sector that has fared well, at least in terms of indices such as the S&P 500, in the past year. The question is whether a similar type of result is possible. The author of this article thinks obtaining results will be a harder task. The writer is Justin White, portfolio manager at the T Rowe Price US All-Cap Opportunities Equity Strategy. The editors are pleased to share these views, and we urge readers who want to get into the discussion to respond. The usual editorial disclaimers apply. Email tom.burroughes@wealthbriefing.com and amanda.cheesley@clearviewpublishing.com

While sentiment towards US equities has certainly improved since August’s downturn, an undertone of nagging uncertainty remains. As we view the prospects for 2025, the US equity market outlook appears finely balanced.

On the one hand, tailwinds, including a growing economy, robust corporate earnings, moderating inflation, and easier monetary policy, are all reasons for encouragement. However, these are balanced out by various headwinds, including a volatile jobs market, negative earnings revisions in the equal-weighted S&P 500 Index, prospective policy uncertainty, as well as heightened geopolitical tensions. 

Given these competing forces, sensitivity to news flow – and the prospect of a higher level of market volatility – is expected to be a feature moving forward. While this can be unsettling, it is also a broadly supportive backdrop for active, process-driven stock picking, as company valuations and fundamental quality come sharply into focus, and the potential for investor overreaction also increases.

Examining the “broadening market” narrative
From a market perspective, we anticipate a slow grind higher on the US equity market in the near term, interspersed with periods of heightened volatility as markets react to macro data and corporate earnings surprises. While some of the root cause headwinds behind the August market correction have been diluted, they have not disappeared altogether. High market concentration, for example, remains an ongoing issue to negotiate.

Encouragingly, the “broadening market” narrative is gradually being borne out in reality, at least across industries/sectors. This is certainly beneficial for larger, growth-oriented holdings outside the Magnificent Seven stocks. However, the broadening of market performance is much less apparent down the market capitalisation spectrum. Company scale is benefiting the larger players in most industries, and this is creating an earnings divide between large and smaller US companies.

Furthermore, substantial investment in artificial intelligence is being dominated by large companies with deep pockets. Smaller companies simply cannot compete, putting them at a relative disadvantage, given the enhanced productivity and decision-making potential that AI offers.

With so much investor attention focused on the top end of the market, smaller companies have effectively been relegated to the background in recent years. As a result, rather than being driven by individual company or industry-specific fundamentals, the small-cap market is currently moving in broad unison, swayed by headline macro data, as well as basket purchase programs, such as ETFs.

Looking ahead, we see underappreciated value in US smaller companies, but we would need to see some sort of catalyst or fundamental shift in the landscape for this value to be broadly realised.

Markets behaved rationally amid volatility
One of the more surprising, and encouraging, features of the recent August volatility was that US equity markets generally behaved rationally. Most sectors and stocks performed in line with respective earnings per share revisions, while any stocks that exceeded or missed expectations were rewarded and punished, respectively.

This is precisely how efficient markets should function, leading to a broader dispersion in returns as better-quality companies with improving fundamentals separate from lower-quality ones. In this environment, the importance of a consistent, process-driven stock-picking framework increases greatly.

In terms of sectors, healthcare is currently presenting attractive investment opportunities, in our view. The sector encompasses a range of industries and a wide array of businesses, many of which we believe appear reasonably valued. In addition to the healthcare sector’s inherent defensive characteristics, many companies appear to feature compelling idiosyncratic and durable growth stories.

Looking longer term, it is going to be fascinating to see how AI impacts the healthcare sector, from advancement in robotics and precision surgery to enabling the discovery and diagnosis of novel treatments.

The technology is still in its infancy, but AI could have a disruptive impact in terms of greatly improved patient treatment/long-term care. Identifying the likely winners at an early stage represents a potentially huge investment opportunity.  

Given the finely balanced outlook, US equities could see a higher level of volatility in 2025 as sentiment shifts in reaction to the latest macroeconomic data and earnings updates. While returns will be harder earned in this environment, volatility presents opportunities for active managers who stay anchored to fundamentals and reject false narratives to find mispriced companies. In our view a robust process for identifying good quality businesses that are reasonably priced will be the key to outperforming.