By Thomas O. Herrick
Market Strategist
Following a rough December, stocks got off to a good start in 2025. The S&P 500 has gained 2.27% through this writing. Small and mid-caps, as defined by the Russell 2000 and Russell Mid Cap, are up 2.51% and 4.06%. Value stocks have generally performed better than growth, with the Russell 1000 Value Index up 5.12% and the Russell 1000 Growth Index ahead by .56%. Notable so far in 2025, the equal-weight S&P 500 is ahead of the cap-weighted S&P 500 Index, with the equal-weight up 4.04%. Equal-weight ahead of cap-weighted, value ahead of growth, and solid small-cap performance all indicate expanding market breadth and shifting market internals. Dramatic evidence of this dynamic was seen this week, with mega-cap tech selling off more substantially than the rest of the market as fear escalated due to perceived AI competition emanating from a Chinese start-up lab, DeepSeek.
The most significant fundamental driver of stock prices is earnings expectations. The proximate trigger for stocks rising or falling is rising or falling earnings expectations. Valuations are a fallout of this dynamic. Earnings expectations have been rising for two years within the major stock averages, but a huge portion of those gains have come from the Magnificent 7 (Mag 7) mega-cap tech stocks. Consequently, that group has accounted for the bulk of earnings growth and equity gains, particularly influencing S&P 500 Index performance. As a cap-weighted index, this is the primary reason for dramatic outperformance. There are similar results seen in other cap-weighted indexes.
Mag 7 Influence Beyond The S&P 500
Source: Glenmede Investment Management, FactSet. As of 12/31/2024. Past performance is not indicative of future performance.
Our 2025 Market Outlook features a viewpoint that this market internal will evolve going forward. The basis for that opinion is that while Mag 7 names should continue to outpace the other 493 names within the S&P, the earnings growth gap between the two groups will diminish. Expectations are for the growth rate of Mag 7 stock earnings to be lower, while at the same time, consensus expectations are for the other 493 stock earnings to accelerate. The consequence of this outcome would be a more consistent breadth expansion in the overall market. The other consequence is that a more diversified, equal-weight approach should do considerably better than in recent years. Indeed, January results are an inkling of what may be in store.
Source: FactSet, Goldman Sachs Research
To be clear, the market still needs participation from mega-cap tech stocks. A binary outcome in which the Mag 7 has falling earnings expectations would take down major averages due to their heavy weighting and likely lower the entire equity market. When major averages decline, selling becomes indiscriminate. Indeed, as this commentary is being written, equity markets are struggling with sharp declines sourced from news out of China regarding a new AI competitor to mega-cap tech names. If that competitor were to indeed provide a cheaper, better AI model than major US firms there could be a significant impact on mega-cap tech earnings expectations.
All market performance figures are sourced from Bloomberg.
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