5 Investing Themes for 2025: Thriving Amid Uncertainty

The past two years have been remarkable for stock investors. Between September 2022 and November 12, 2024, the S&P 500® Index surged by an impressive 67%. This rally persisted despite significant economic and political uncertainties. As we move into 2025, the outlook remains murky—an environment that has historically been favorable for equities. Below, we delve into five investing themes for 2025, exploring why uncertainty could be a boon for stocks and how investors can capitalize on emerging trends.

Seeking Clarity in a Cloudy Environment

The U.S. economy enters 2025 with no shortage of challenges. Questions loom about the effectiveness of the new administration, the direction of interest rates and inflation, geopolitical risks, and the broader economic trajectory. Small-business owners, a key pillar of the U.S. economy, are grappling with unprecedented uncertainty. The National Federation of Independent Business (NFIB) Small-Business Uncertainty Index recently reached its highest level ever.

Yet, history offers a silver lining. High uncertainty has often been followed by robust stock market performance. When the NFIB Uncertainty Index has been in the top 5% of its range since 1974, the S&P 500 has delivered an average 12-month return of 22%. This pattern suggests that anxiety-driven markets may overlook tailwinds, paving the way for strong gains.

When Oil Prices and Interest Rates Align

A unique confluence of factors could further buoy stocks in 2025. Over the past 12 months, both oil prices and the 10-year Treasury yield have declined significantly. Historically, such simultaneous declines have led to above-average stock returns. Since 1980, when both metrics fell by 15% or more, the S&P 500 posted an average 18.9% return over the following year. Notably, cyclical stocks have been the biggest beneficiaries during such periods.

Cyclical sectors, including communication services, consumer discretionary, energy, financials, industrials, materials, real estate, and technology, have outperformed defensive sectors when oil and interest rates fell together. Real estate has historically been the standout, while utilities have lagged. This dynamic sets the stage for a cyclical resurgence in 2025.

Five Investing Themes for 2025

Drawing on these insights and broader market trends, here are five themes that could shape investment strategies in the coming year:

1. Stocks Over Bonds

Several indicators favor stocks over bonds in 2025. Falling oil prices and interest rates provide a supportive backdrop. Additionally, valuation spreads—the gap between the most- and least-expensive stocks—remain wide, historically a bullish signal for equities. Moreover, bond market volatility has outpaced that of stocks, suggesting a more stable environment for equity investors.

Historically, when these conditions aligned, stocks have outperformed bonds significantly. Investors should consider maintaining or increasing their equity exposure, particularly in sectors poised for cyclical growth.

2. Overweight Financials

The financial sector has already had a strong 2024 but remains attractively valued. Despite recent gains, the sector’s valuation sits in the bottom quartile of its historical range. Since 1962, financials have outperformed the market by an average of 500 basis points when starting from similar levels. Valuation spreads within the sector are also elevated, further enhancing its appeal.

Historically, financials have a 68% probability of outperforming the market over the next 12 months when spreads are at these levels. Investors may want to consider overweighting financials in their portfolios, focusing on companies with strong fundamentals and attractive valuations.

3. Overweight Consumer Discretionary

Consumer discretionary stocks have become increasingly attractive after a year of declining valuations. The sector’s price-to-free-cash-flow ratio is now in the bottom quartile of its historical range. Since 1980, consumer discretionary stocks have had a 70% chance of outperforming the market from similar valuation levels, with average outperformance of 800 basis points.

What makes the sector particularly compelling is its earnings growth. Over the past 12 months, consumer discretionary earnings have exceeded the broader market’s growth rate. This rare combination of low valuations and strong earnings momentum positions the sector for a potential breakout in 2025.

4. Be Cautious of Utilities

While cyclical sectors look promising, defensive sectors, particularly utilities, may struggle. Utilities have historically underperformed following periods of falling oil prices and interest rates. Since 1962, the sector’s returns have trailed the market by double digits on average during such periods.

Adding to the sector’s challenges, yields on 10-year Treasurys have risen even as the Federal Reserve has cut interest rates—an uncommon scenario that has historically been bearish for utilities. Investors should exercise caution and consider underweighting utilities in favor of sectors with stronger growth prospects.

5. Consider Mid-Caps

Mid-cap stocks offer a compelling opportunity for 2025. Valuations based on book value and earnings are attractive, and the sector’s earnings growth has accelerated. Analysts project continued strength in mid-cap earnings, a bullish signal for the year ahead.

Historically, mid-cap stocks have outperformed large caps when valuations have been this favorable. Since 1990, the cheaper mid-caps have been relative to their historical range, the higher their likelihood of outperforming large caps over the next 12 months. Investors seeking diversification and growth should consider increasing their mid-cap exposure.

Navigating Uncertainty with Confidence

The cloud of uncertainty hanging over 2025 may seem daunting, but history suggests it’s an opportunity, not a threat. Stocks have historically thrived in periods of heightened anxiety, and the current market setup appears favorable for cyclical sectors and equities broadly.

By focusing on these five themes—stocks over bonds, overweighting financials and consumer discretionary, cautioning against utilities, and embracing mid-caps—investors can position themselves for potential success in the year ahead. As always, diversification and disciplined risk management remain essential components of any investment strategy.

2025 promises to be a year of challenges and opportunities. By staying informed and proactive, investors can navigate the uncertainty and potentially capitalize on the trends shaping the financial markets.