After the strongest two-year period for multi-asset investors since the late 1990s, we enter 2025 with a rapidly evolving macro environment and a more complex backdrop for investors to navigate. Our annual Top 10 Investor Themes is intended to help investors focus on the key forces we expect to shape the path forward for markets in the new year.
10. Normalizing Price Correlations
Price correlations among S&P 500® stocks reached a 10-year low in 2024 of 0.03 compared to the average of 0.33 over the same period. Although low intra-stock correlations are generally positive for markets (because it means stocks are trading on individual fundamentals and not as a broad group), in 2024, the extremely low correlation was due to highly concentrated performance driven by a small number of mega-cap tech companies. The correlation between equity and fixed income was a further detriment to markets in 2024 as high correlations reduced the benefit of diversification. In fact, since mid-2022, the S&P 500 and the Bloomberg U.S. Aggregate Index have had a high positive price correlation of 0.58 versus the 10-year average of 0.12. Should earnings growth broaden across sectors as we expect while Federal Reserve (Fed) policy continues to loosen, correlations could revert toward the mean, which would support active management and diversified portfolios in 2025.
9. Private Market Rebound
We believe private markets will see an uptick in deal flow in 2025, paving the way for a pickup in merger and acquisition activity as well as new opportunities in venture capital, private credit and select categories of real estate. Because consensus expected a mild recession in 2024 that never materialized, we believe potential deals and other activity that was sidelined during the year could potentially come back to market in 2025. Elevated valuations, however, remain a headwind.
8. Reassessing Cash Allocations
Given the Fed is expected to continue cutting its policy rate into 2025, we expect investors to reassess their potentially outsized cash allocations. While cash can offer relatively attractive risk-adjusted returns during periods of rapidly rising interest rates, over the long term, cash tends to lag stocks and bonds, which can limit portfolio growth over time and lead to increased shortfall risk. Further Fed rate cuts could also make cash allocations less attractive. For additional insights, please see our commentary Is Cash Burning a Hole in Your Pocket – or Worse, in Your Portfolio.
7. Expanded Artificial Intelligence Use Cases
In the two years since OpenAI launched its ChatGPT chatbot, artificial intelligence demand is still primarily benefiting the semiconductor industry. However, 2025 could be the year of expanded use cases into other industries and sectors beyond Information Technology. Should adoption grow at scale, its potential efficiency enhancements could give operating margins a needed boost to help sustain earnings growth.
6. Broader Earnings Growth
After most equity asset classes outside of U.S. large cap had negative earnings growth in 2024, we expect a strong rebound in 2025. U.S. mid- and small-cap equities and emerging markets are expected to grow earnings by double digits. Additionally, even the S&P 500 excluding the “Magnificent 7” mega-cap tech stocks is expected to produce earnings growth of 13%. Should the U.S. business cycle experience a mid-cycle reacceleration, we believe earnings growth could broaden to sectors such as Energy, Materials and Industrials as they are highly correlated to economic growth.
5. Valuation Headwinds
Global equities had strong returns in 2024 due to earnings multiple expansion — not earnings growth. As a result, U.S. equity valuations across market caps are back to levels near the peak of the cycle in 2021. The 10 largest stocks in the S&P 500 ended 2024 at an average forward price-to-earnings ratio of 34.7x versus 20.2x for the remaining 490 stocks in the index. On a monthly basis, this is the 12th largest valuation differential in the past 10 years. While the 10 largest stocks are expected to deliver robust earnings growth in 2025, we believe valuations in 2025 will be highly dependent on broad earnings acceleration.
4. Secondary Wave of Inflation Concerns
The ongoing strength of the U.S. labor market has kept consumers resilient and the economy powering ahead. With the U.S. consumer driving nearly 70% of GDP, the outcome for the economy and earnings relies heavily on consumers’ ability to withstand the cumulative effects of inflation, tighter lending standards, dwindling savings rates and rising credit balances.
3. Less Accommodative Monetary Policy
The December Federal Open Market Committee meeting indicated the Fed is adjusting its economic outlook, leading to expectations for less aggressive interest rate cuts in 2025 than originally anticipated. Compared to estimates at the time of the Fed’s first cut in September, the market now expects the total amount of cuts to be 75 basis points (bps) lower, and the PNC Economics team only expects 50 bps of cuts in 2025. In our view, stickiness in core services inflation, due to components such as housing, wage growth and the potential impact of inflationary tariffs, could translate into a shallower Fed easing cycle than investors are expecting.
2. Deficits & Debt Levels
With the federal deficit already at levels typically seen during a recession, large amounts of increased borrowing could lead to inflationary pressure, and ultimately, higher longer-term interest rates. Indeed, the deficit-inflation feedback loop appears to already be influencing market behavior. For example, while the Fed cut its policy rate by 75 bps from September to December 2024, the 10-year U.S. Treasury (UST) yield increased approximately 90 bps over the same period. Coinciding with a rise in the federal deficit has been an increase in short-term issuance by the Treasury, which we believe is adding to UST market volatility. The ICE BofAML MOVE Index, a proxy for interest rate volatility, remains moderately higher than its 20-year average as investors adjust to bond market concerns about the deficit.
1. Fiscal Policy Uncertainty
With a change in political administration and heightened awareness of growing U.S. debt and deficit levels, we expect fiscal policy to be a focus for markets in 2025. From foreign trade and tariff policies to tax reform and the fate of the debt ceiling, we expect the potential for policy changes to create uncertainty that may have a material impact on global markets.
2025 Song of the Year: “Purple Haze” by The Jimi Hendrix Experience
With its surreal, psychedelic lyrics and distorted sound effects, the song “Purple Haze” could be a metaphor for investors’ journey toward clarity in 2025. We entered 2024 with many unanswered questions — about inflation, interest rates, consumer health, election outcomes and more. While many questions were answered throughout the year, investors may still be caught in a haze, uncertain about how these key macro forces will come together to help drive market outcomes in 2025.
On the surface, the song seems to speak to feelings of confusion, disorientation and altered perceptions of reality. Given the winding road investors have traveled, not only in the last year, but since the pandemic, we think this characterization is a fitting sentiment for investors too! To us, however, what’s also implicit in the lyrics is a belief that the haze will eventually clear and lead to a more enlightened state, again reflecting our hope for markets in the new year.
To put a literal spin on the market’s purple haze of 2025, some of the key macro forces taking shape in the new year will be influenced by decisions made in Washington, D.C. If all these macro forces managed to align, and the red and blue political parties also managed to work together (which, when combined, make the color purple), wouldn’t that be a dream come true?!
