U.S. stocks recorded their best two-year performance in 25 years, the strongest since the eve of the internet bubble burst

In 2024, the U.S. stock market performed strongly again, with the S&P 500 index recording an annual increase of 23% and hitting a historical closing high 57 times, thanks to the robust U.S. economy, cooling inflation, and a rally in large tech stocks driven by artificial intelligence. Although the U.S. stock market saw a pullback in the last few trading days of 2024, the S&P 500 index still recorded the strongest consecutive two-year gain since the eve of the internet bubble burst in 1997-1998.

The assets that surged significantly in 2024 were not limited to stocks; gold achieved its best annual performance since 2010, and Bitcoin more than doubled over the year, briefly surpassing the $100,000 mark, although it has recently fallen back below that level.

The rise in major asset classes has made professional investors increasingly optimistic:

Many investors believe that although the Federal Reserve's interest rate cuts are not expected to be as significant as some hope, the overall resilient U.S. economy and the Fed's rate cuts will continue to support the U.S. stock market.

In a global fund manager survey released by Bank of America in December, the net percentage of respondents holding an optimistic view on U.S. stocks reached a historical high.

According to predictions from 16 Wall Street investment banks compiled by Opening Bell Daily, each investment bank forecasts that U.S. stocks will continue to rise in 2025, with the S&P 500 index expected to increase by 7%-19% cumulatively.

However, some industry insiders warn against expecting the rapid gains of the U.S. stock market in 2023 and 2024 to be replicated in 2025, as 2025 may experience a bumpy trajectory.

Headwinds Facing the U.S. Stock Market in 2025

Interest rates present uncertainty, which may suppress further gains in the U.S. stock market. Rates could be higher than expected, raising financing costs and providing investors with more low-risk alternative investments. In fact, the yield on U.S. benchmark government bonds has significantly risen since the low in September.

The Federal Reserve recently expressed concerns about the extent of further rate cuts. After announcing a rate cut in December, the Fed indicated that there may only be two more cuts next year, suggesting that rates may remain above previous market expectations. As a result, the Russell 2000 index plummeted 4.4% on that day, marking the largest single-day drop in two and a half years; the Dow Jones Industrial Average also experienced ten consecutive trading days of decline in December, setting the longest losing streak since 1974.

The current valuation of U.S. stocks is expensive. According to FactSet, as of late last week, the expected price-to-earnings ratio for the S&P 500 over the next 12 months is 21.9 times, higher than the average of 18.5 times over the past decade. Although some investors believe that the current market's high proportion of tech stocks and strong growth warrant a higher valuation, many are still concerned about overpriced stocks.

While high valuations may not necessarily reverse market gains in the short term, in the long run, high valuations could lower potential returns for investors, meaning that corporate earnings growth is crucial for stock price performance.

According to FactSet, Wall Street analysts expect S&P 500 companies' earnings to grow by 15% in 2025, up from the 9.5% forecast for 2024. The market's punishment for underperforming companies is becoming increasingly severe. For example, after software giant Adobe released weak sales guidance recently, its stock price fell by 14% in a single day Over the past year, investors have become cautious about when corporate spending on artificial intelligence will truly translate into profits. Previously, both Google's parent company Alphabet and Amazon faced stock price setbacks due to high investments contrasted with less-than-ideal revenue growth.

There are also many uncertainties in the political landscape of the United States. After the Republican Party's significant victory in the elections in November, the market initially optimistically believed that tax cuts and deregulation would benefit business development. However, President-elect Trump also proposed large-scale tariffs and mass deportations, which, if implemented, could exacerbate inflation.

Future Focus on Market Breadth

The "Seven Sisters," a group of mega-cap technology stocks, are the main driving force behind the rise of the S&P 500. As of December 24, the "Seven Sisters" accounted for over 53% of the total return (including dividends) of the S&P 500, with Nvidia alone contributing as much as 21%.

At the same time, several sectors such as finance, utilities, and industrials have also performed well: the financial sector rose by 28% over the year, while utilities and industrials increased by 20% and 16%, respectively.

Looking ahead to 2025, many investors expect the market breadth to expand, with stocks outside of large technology companies having more attractive valuations and room to catch up with the tech sector.

The small-cap sector has drawn market attention. Currently, the Russell 2000 index is still about 9% lower than its record high in November 2021, while the S&P 500 has risen by 25% during the same period. This significant gap has led some fund managers to believe that small-cap stocks have the opportunity for "mean reversion" and to gain catch-up opportunities. Analysts expect that if the Federal Reserve continues to cut interest rates, small-cap stocks may benefit from this. Compared to large companies, small companies often issue more floating-rate debt, so their financing costs tend to decrease more quickly when interest rates decline