Market performance over the last two years has shared a unique distinction: very few stocks outperformed the index. As the chart at right conveys, we have endured the “narrowest market since the tech bubble”[1] .
The behavior of equity markets during the first month of 2025 would suggest that the abnormal concentration of returns may be giving way to a more normal distribution. Should this trend continue throughout 2025, investors are poised to benefit from an enhanced focus on diversification.
This became quite evident on the last Monday of January. Nvidia’s stock price plummeted 17%, erasing $589 billion from its market cap. It was the the day of the “DeepSeek rout”[2].
While this event was quite damaging to the stock prices of many AI related companies, it did not prove to be negative for most stocks. As depicted in the chart at bottom right, most stocks were positive on the day as 199 more stocks advanced rather than declined in the S&P 500[3].
We have highlighted the importance of diversification throughout our conference calls and weekly communications over the last several months and it is also referenced heavily in our recently published Capital Market Assumption White Paper. A review of performance for the month of January enlightens the market reversal that reflects the power of diversification.
Global equity markets delivered a strong month across the board as stocks rebounded from a difficult December.
Stock sector movements were consistent with the theme of improved breadth as many sectors reversed their performance from last month.
Our Navigator framework informs our outlook.
Economy: Consumer spending remains strong even though GDP growth slowed during the 4th quarter. Inflation is still a risk to the outlook as three key measures reaccelerated in the final quarter of 2024. Earnings estimates look healthy for 2025 and there is a positive inflection expected for small and mid-cap firms.
Technicals: The broad US equity market remains in a positive trend as the advance/decline line turned positive during January. The “DeepSeek rout” that occurred on the last Monday of the month showed a sign of potential risk for extended AI stocks. Nvidia dropped 17% in response. It represented the largest drop for the largest US company since 1990. In addition to equity volatility, bond market volatility remains elevated in the face of economic uncertainty.
Sentiment: Investor sentiment remains positive after a temporary drop in January. After a 3-month improvement in jobs becoming easier to come by, January saw a move backward. Consumer sentiment took a step backward as well. Despite the mixed signals over the last month, the stock market remains quite close to its all-time high.
Valuation: Valuation levels remain historically expensive for large cap US equities with P/E ratios and dividend yields at extremes. The valuations of small and mid-caps and international equities are more reasonable. Technology’s share of market cap in the US far exceeds its share of net income. Given the concentration that tech has established in the market, this represents a risk for returns over coming quarters. The spread should narrow with improved earnings breadth in 2025. Within fixed income, mortgage bonds offer an attractive entry point relative to corporate bonds.
Over the long run, the success of investing in the stock market depends on two key variables: the first is the compound annual growth rate (CAGR) of earnings and the second is the price one must pay for the earnings (valuations). If one assumes that valuations normalize over time and the price of entry and exit is near the long-term average valuation, then long-term returns are going to show a high correlation with earnings growth. In the short term, both earnings and valuations can vary widely across asset classes.
This chart highlights the difference in earnings growth between the Magnificent 7 (Mag 7 includes Apple,
This earnings exhibit does offer some explanation for the concentration of performance discussed at the onset of this note. We believe the difference in fundamentals allowed many investors to ignore the rest of the market to focus solely on the segment with outstanding earnings. As earnings broaden throughout the year, market performance should follow suit.
The exhibit to the right offers some additional support. Earnings growth for the S&P 500 is expected to advance at a faster rate in 2025 than it has in any of the past three years and every sector of the market is currently forecast to experience a healthy year of progress on the earnings front. These factors bolster the principle of embracing greater portfolio diversification.
The anticipation of improved breadth for a diversified approach within the S&P 500 focuses primarily on large cap stocks. For the theme of broadening earnings and returns to truly take hold, participation from Small and Mid-Cap stocks would seem to be a prerequisite.
As this chart illustrates, earnings growth expectations for Small and Mid-Caps exceed the expectations of
These expectations may prove to be a bit too rosy as the market expects earnings to grow by double digits for each of these asset classes in 2025 and 2026[5]. Analysts often have optimistic forecasts early in the year and tend to reduce expectations as the year progresses. It may not be prudent to expect earnings to be as robust as current estimates, but the smaller market cap companies look set to deliver much better relative results.
Risks and Opportunities in the Year Ahead
The case for a broadening of earnings and return dynamics in the equity market can only come to fruition if the economy provides the proper setting. The consumer should continue to spend as long as the employment outlook remains reasonably firm. So, the employment side of the Fed’s dual mandate appears to be solid for now. Price stability, on the other side of the mandate, could be at risk if growth surprises to the upside. Persistent inflation could stymie the Fed’s flexibility to continue lowering interest rates. Earnings would most likely be strong, but the net effect could lead to higher volatility and lower valuations in equity and bond markets.
Weaker than expected growth could also present challenges, especially if unemployment were to spike. Inflation fears would likely dissipate, and the Fed would have flexibility to cut rates; but consumer spending and earnings would likely suffer material setbacks. These risks are well understood, and they are always present to varying degrees.
It’s the risks and opportunities that are newly present with the change in administration that have the market on edge. The current issues with accompanying risks and or opportunities are as follows:
Each of these issues has the potential to impact the markets throughout the early years of President Trump’s second term as President. The timing and magnitude of implementation remain uncertain, so we should anticipate episodes of increased volatility over the intermediate term.
Our positioning continues to reflect our long-term focus paired with active risk management:
After two years of narrow market performance, we believe it is of paramount importance for investors to focus on diversification and adherence to long-term plans as guiding lights for portfolio construction.
This material is intended to be educational in nature, and not as a recommendation of any particular strategy, approach, product or concept for any particular advisor or client. These materials are not intended as any form of substitute for individualized investment advice. The discussion is general in nature, and therefore not intended to recommend or endorse any asset class, security, or technical aspect of any security for the purpose of allowing a reader to use the approach on their own. Before participating in any investment program or making any investment, clients as well as all other readers are encouraged to consult with their own professional advisers, including investment advisers and tax advisors. OneAscent can assist in determining a suitable investment approach for a given individual, which may or may not closely resemble the strategies outlined herein.
[1] Source: Richard Bernstein Advisors, LLC.; B of A Merrill Lynch US Strategy.
[2] Source: Bloomberg story “Nvidia’s $589 Billion DeepSeek Rout Is Largest in Market History”.
[3] Source: Bloomberg story “Tech’s DeepSeek Slump Left Rest of Market Historically Unscathed”.
[4] Source: Bloomberg Intelligence.
[5] Source: Earnings estimates collected by Bloomberg.
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