It seems investors entered 2025 with guarded optimism. Interest rates and inflation are stable, and household finances continue to improve. The labor market continued to add more workers, slowly reducing the millions of unfilled jobs, and the unemployment rate dropped again in January to 4.0%. Small business owners surveyed last month by the National Federation of Independent Businesses (NFIB) responded with the strongest increase in optimism in years. 

So why did the guarded optimism and rocky start in 2025?   Probably the biggest factor concerning investors is how well the US stock market has performed since bottoming in late 2022.   Since October 2022, the US major indices have been on a torrid rally as investors are scooping up stocks of fast-growing companies in a wide variety of industries specifically in technology. Below are the returns of the US indices from October 13, 2022, through today:

• NASDAQ: 88.20%

• S&P 500: 67.02%

• MSCI Ex US: 53.07%

• Dow Jones Industrial Average: 48.33%

• S&P 400 Mid Cap: 40.15%

• S&P 600 Small Cap: 27.70%

• S&P Bond: 16.76%

Technology continues to lead the pack with the added boost from AI companies.  Also, you may notice the significant underperformance of the S&P 400 Midcap and S&P 600 Small-cap indices to large-cap S&P 500 and NASDAQ.  Seasoned investors know that at some point in the future, this lineup of winners and losers will be reversed and provide new investing opportunities.  However, the key is knowing when to make the changes in your account to the underperforming indices.  We will discuss more on this later in the article.

For the start of 2025, we have not seen evidence of a change in institutional investors’ appetite for US stocks of the largest companies and technology.  The one change so far this year is the jump in the MSCI Ex-USA which is leading the group for the first time in years.

• MSCI Ex US: 7.41%

• Dow Jones Industrial Average: 4.73%

• S&P 500: 4.22%

• NASDAQ: 3.78%

• S&P 400 Mid Cap: 3.37%

• S&P 600 Small Cap: 2.07%

• S&P Bond: 0.82%

The foreign markets have been underperforming the US for years with many top foreign company stock valuations at significantly lower ratios of stock price to earnings (referred to as Price to Earnings or P/E) than US companies. What the P/E ratio defines for investors is how much the stock is selling for the earnings the company provides.  In real estate terms, houses all have different P/E ratios of the value of the house to the rent income.  If for example, one house value is $250,000 that earns $18,000/year ($1500/month), the P/E ratio is 7.2%.  Compare that to a house valued at $750,000 that earns $48,750/year ($4,062/month) that only has a P/E ratio of 6.5%.  The lower-value home has a better return on investment (ROI) based on rent income.  However, the higher valued home may be in a nicer neighborhood and could make up the difference of a lower P/E ratio with better appreciation providing an overall better ROI.

The potential for investors buying stocks of foreign, emerging market, mid-cap, and small-cap stocks at current lower values is earning superior returns as their valuations improve. 

Unfortunately, the discount opportunity of a foreign, emerging market, mid-cap, and small-cap stocks has been a discussion point for years among analysts with projections of terrific profits “next year”.   However, for the past 10 years, the foreign, emerging market, mid-cap, and small-cap stocks have significantly underperformed to the S&P 500 and most exceptionally NASDAQ.  Look at how wide the spread is between the S&P 500 and NASDAQ and the other indices since January 1, 2016:

• S&P 500: 305.00%

• NASDAQ: 192.30%

• S&P 400 Mid Cap: 116.10%

• S&P 600 Small Cap: 103.80%

• Dow Jones Industrial Average: 88.85%

• MSCI Ex US: 23.95%

• S&P Bond: 15.50%

If one was a buy-and-forget investor and ignored their allocations that were focused on foreign, emerging market, mid-cap, and small-cap stocks, their potential underperformance would have been significant.  One key to building wealth and successful investing is keeping your portfolio in the market sweet spot of positive momentum.  It’s a process of constantly evaluating market trends, economic data, and institutional activity to determine opportunities and positive momentum.  More importantly, is identifying changes in long-term momentum so long-term profits don’t dissipate or worse turn into losses.

As we have discussed, our investment process in managing our five model portfolios incorporates defining and monitoring the momentum.  In other words, should the momentum of the S&P 500 begin to slow in comparison to its peers it would be like an Indy Car with engine problems slowly being passed up by the field and sinking further to the back of the pack.   However, if the same Indy Car is running great it would keep its lead or maybe even increase its lead.  

The challenge is correctly identifying if momentum has changed when short-term contrary market cycles develop.  Meaning, that short-turn declines during a growth trend or opposite, short-term rallies in a declining trend.  During these contrary cycles, it is an opportunity for investors to buy or sell depending on the established momentum. 

For example, tech stocks, and specifically AI stocks have soared in price with outstanding positive momentum these past several years.  However, on January 27, 2025, DeepSeek, a little unknown Chinese company with about 200 employees, announced that their AI Assistant powered by DeepSeek-V3 had overtaken rival ChatGPT as the top-rated free application on Apple’s App in the US.  More alarming to investors, is DeepSeek co-founder Liang Wenfeng stated they matched the abilities of ChatGPT at a “software training” cost of less than $6M compared to the billions spent by the tech titans for similar results.  Investors panicked causing mass hysteria of selling that by the end of the day over $1 trillion of stock capital had been lost.  Was this a “Sputnik Moment”  for US tech titans that will dramatically compromise future earnings and stock valuations?  Based on the panic selling by institutional managers it appeared they thought so. 

More importantly, was January 27 the beginning to the end of the positive multi-year momentum of the tech sector?

It has been a mere 22 days since DeepSeek’s announcement in January, and the evidence so far is institutional investors have not lost their interest in the AI tech sector nor has the momentum changed.  Nearly every day since January 27, analysts have made the point to reiterate their strong buy or overweight rating on many of the leading AI companies.  As a result, the January 27th tech selloff appears to have been a terrific buying opportunity as the stocks of many of the AI companies have bounced back and some to new all-time highs.  Note the returns of key AI stocks since January 27 through today:

• Palantir: 65.16%

• Nvidia: 17.67%

• Oracle: 13.60%

• Broadcom: 12.80%

• Meta Platforms: 8.56%

• Apple: 6.37%

• Alphabet: -4.14%

• Tesla: -10.99%

What Does This Mean to Me?

We maintain our favorable view of the US economy and stock markets.  We reiterate our view the US stock market is in a positive trend.  Our view for 2025 is market correction cycles may be more volatile and longer in duration creating new buying opportunities for investors.  Also, we are identifying several other industries that have favorable growth opportunities that are not in the tech sector.  The “broadening” of the marketplace is healthy for the overall stock market rally and for the economy.  It is not healthy for the economy when only a handful of companies in the same industry are driving the economy.  The diversification of growing businesses is one aspect that keeps the duration of a growth economy going.

Give us a call or send an email to let us know what you think about this UPdate.  More importantly, let's schedule a time to meet and discuss your financial goals and how we can assist you and your family in achieving them.