Review & Outlook
January 9, 2025
It was another strong year for the stock market, with notable performance across major indices:
- S&P 500 Index (Market Weight) – 25.02%
- S&P 500 Index (Equal Weight) – 13.01%
- Dow Industrial Average (Price Weight) – 14.99%
This marks two consecutive years of double-digit returns, largely driven by the Artificial Intelligence (“AI”) theme and the anticipation of lower interest rates. While these returns are robust and well above our Investment Plan expectations, it’s important to note that not all stocks have kept pace. In fact, only 28% of stocks outperformed the S&P 500 Market Weighted Index, a significant departure from the typical 45% to 50% range. This divergence was last observed during the Technology bubble of the late 1990s.
Upon further analysis, we found that Lower Quality stocks—those with limited profits but high expectations based on AI technologies—were among the leaders, along with sectors that were hardest hit by the pandemic (e.g., banks, airlines, cruise operators). As you know, these are areas we generally prefer to avoid.
Carderock’s strategy of maintaining a broadly diversified set of high-quality growth stocks has led to performance that, on average, falls between the Market Weighted and Equal Weighted S&P Indices. Our 39 years of experience have allowed us to stay the course during various market cycles and avoid the risks of chasing thematic trends. We have successfully navigated euphoric periods driven by Real Estate (1980s), Technology (1990s), and Financials (2000s) without overextending our portfolios, while observing the eventual market corrections that followed.
To us, the current environment appears no different. AI investments, although promising, are heavily capital-intensive and largely speculative at this stage. The large-scale investments by Big Tech in AI remind us of the Red Queen’s advice to Alice in Alice in Wonderland— “You have to run as fast as you can just to stay in the same place.” While we are confident that remarkable technological advancements will unfold, it remains unclear who will emerge as the long-term beneficiaries. We expect the market to continue pricing in the transition to an AI-oriented economy, but it will likely take years before these technologies fully impact our daily lives. In the meantime, we will resist the temptation to excessively concentrate our investments in this area until there is a clear path to sustained profitability.
Our View for 2025
- Economic Growth – We anticipate growth in the 2% to 3% range, supported by a strong labor
market, rising wages, and ongoing demand. - Interest Rates – We foresee modest reductions in rates as the Federal Reserve manages the
balancing act between a slowing real estate market, modestly rising unemployment, and a resilient
economy. - Investment Outlook – While AI continues to attract substantial investment, higher interest rates
are likely to restrict capital flows into other capital-intensive sectors.
Stocks
- Earnings Growth – Remains strong, though largely confined to sectors less sensitive to interest
rates. - M&A Activity – Expect an uptick as the regulatory environment softens.
- Profit Margins – Should continue to improve, barring any major input inflation caused by tariffs.
Fixed Income
- The Yield Curve – We anticipate normalization as short-term rates decrease, making laddered
portfolios more attractive than in recent years. - The Federal Reserve – Faces a challenging position between growth and rising unemployment,
limiting its ability to make substantial rate cuts in the near term.
Final Thoughts
Although valuations are stretched at the start of the year, we remain optimistic about the outlook for stocks, especially as emerging industries continue to recover from the post-COVID period. We do expect increased volatility as investors process the impact of new government policies and international conflicts, which could result in realized capital gains exceeding 2024 levels.
However, our approach remains unchanged: we are committed to managing your portfolio with a focus on quality growth stocks, bonds, and cash reserves, providing the balance and consistency of returns necessary to meet your long-term objectives.
As always, we are available to discuss your investment progress or answer any questions you may have.
Please don’t hesitate to reach out.
Daniel A. Kane, CFA
President
Stephen F. Knapp, CFA
Director of Research
