I had the privilege of speaking with some top investment thinkers for Morningstar’s The Long View podcast this past year. Christine Benz, other colleagues, and I interviewed portfolio managers, strategists, and economists. Many—though far from all—of my favorite moments from 2024 are included in the Best of The Long View: Investing episode.
Several common themes emerged from the interviews. As investors think about portfolio positioning for 2025, here are a few ideas I found compelling:
Tread Carefully in US Equities
Whether it was the investment team at Primecap Management, Pimco CIO Dan Ivascyn, or market historian Jeremy Grantham, several guests sounded warnings about the US stock market. It’s no secret that a handful of stocks have dominated. Nvidia NVDA and Microsoft MSFT now exceed $3 trillion in market capitalization; both Amazon.com AMZN and Alphabet GOOGL are worth more than $2 trillion; and Meta Platforms META is approaching that mark. Concentration levels have risen markedly, with the top 10 constituents of the Morningstar US Market Index representing 31% of its weight. That well exceeds the 24% level reached in the late 1990s, which rang alarm bells back then and preceded a market crash.
“At some point, the law of large numbers kicks in,” said Primecap’s Joel Fried in early 2024. “We think the market assumes that this group of companies will grow revenues at a compound annual rate of at least 10% over the next five years … That’s an extremely high bar in our opinion.”
Grantham believes that a speculative bubble has inflated on enthusiasm for artificial intelligence’s promise. Comparing AI to canals, railroads, and the internet, Grantham said: “When you have these great developments, they overdo themselves in the short term, they crash in the intermediate term, and then they come out of the wreckage and change the world in the long term.”
Current valuations diminish return potential for US equities. The Morningstar US Market Index trades at a trailing price/earnings ratio exceeding 26, which is reminiscent of the late 1990s as well as 2021. Stocks went on to crash in both 2000 and 2022. According to Ivascyn:
“[A]t the current starting point for high-quality global bond yields versus starting equity valuations, there’s a chance that the returns over the next five or 10 years will be very, very similar with less volatility or less uncertainty in fixed income. There’s even a decent part of the distribution where high-quality bonds outperform equities over that same period.”
Bonds outperforming stocks is not unheard of. For the first decade of this century, the Morningstar US Core Bond Index produced an average annual return of 6.4%, while the Morningstar US Market Index‘s return during that period was negative. Over the past couple of years there hasn’t been much reason for US investors to own bonds over cash, but Sonali Pier of Pimco used a memorable phrase to urge investors to consider a more strategic, long-term fixed-income allocation: “Don’t rent yield.”
Artificial Intelligence Has Serious Investment Implications
Not a single guest we spoke with dismissed the transformative potential of AI. “AI is serious. It will change everything,” said Grantham. Ankur Crawford, an investor in growth equities at Fred Alger Management, foresees massive productivity gains. “When software begins to write software, innovation becomes exponential.” Crawford sees winners in some indirect AI beneficiaries, such as electricity providers to data centers, and Cadence Design Systems CDNS, whose software enables chip design. Jody Jonsson of Capital Group is looking beyond technology companies for innovative applications of AI. “[O]ne of the sectors I’m really intrigued about is healthcare as a potential benefactor, whether that’s coming up with more molecules for drug discovery or speeding up that process or being able to test more of them,” she said.
Like any disruptive technology, AI will also bring losers. Crawford sees many software companies as vulnerable. “[W]hat happens to a software company that resides on code? Is that good or bad for margins? And our conclusion is that over time the margin structure for software businesses will for the most part be under pressure.”
Look For Opportunities Lower Down the Capitalization Spectrum
We spoke with a number of managers who invest in smaller-cap stocks—an out-of-favor asset class. The Morningstar US Small Cap Extended Index had a postelection surge, just as it did after the elections of 2016 and 2020, but the past decade has favored large companies over small ones. The last calendar year in which small caps meaningfully outperformed in the US market was 2016—this despite periods of strong economic growth and interest-rate cuts. Both are supposed to boost the asset class.
While it’s fair to be skeptical of investors singing the praises of their area of focus, our guests JB Taylor of Wasatch Global Investors, Keith Lee of Brown Capital, and Charlie Dreifus of Royce made strong arguments as to why investors should not overlook US small-cap stocks. Dreifus cited the departure from years of low rates and a “risk-on” mindset that favored large caps of a growth persuasion. Lee mentioned the discount at which small companies trade. Highlighting the cyclicality of market leadership, Taylor sees big upside in smaller caps:
“[I]f you go back over the last 100 years, the average performance period of large beating small or small beating large is about 10 years on average. And so, the longest period of large-cap outperformance was 14 years, and it was the period leading right up into the internet bubble … We haven’t seen small caps broadly this cheap versus large caps at any point in the last 25 years.”
Remember Stocks Outside the US
Christine Benz and I got to interview two great global investors live onstage at the Morningstar Investment Conference on a lovely Chicago summer afternoon. David Herro of Harris Associates and Rajiv Jain of GQG Partners answered “yes” to the question posed by the panel title: “Should US Investors Renew Their Passports?” Jain suggested the outperformance of US equities over the past 15 years has made investors forget the benefits of global diversification. He reminded the audience that from 2000 through 2010, “you actually didn’t really make any money in the US.”
Herro expects the situation to change. “I say if it looks bad in the rearview mirror, the front windscreen looks really good.” He pointed to a significant valuation advantage for international equities. “It used to be the US traded at 14%, 15% premium. Today, that number is almost a 50% premium.”
Currency dynamics have contributed to poor returns for international stocks from the perspective of unhedged US investors. “Don’t forget the dollar bottomed in 2014,” said Herro, who argued that the dollar’s appreciation against major global currencies over the past 10 years has resulted in a situation where “looking forwards, you have a double positive: underpriced stocks using underpriced currencies.”
There’s no shortage of investment opportunities outside the US, in the eyes of our guests. Herro, for his part, sees value in many European companies. Jain is a fan of emerging markets like India and Brazil. According to Carl Vine of M&G, [T]here’s an incredibly strong and potentially long-term structural earnings story for the Japanese equity asset class.” Vine also called Japanese small caps “the most fascinating little pocket of the global equity market.” Justin Leverenz of Invesco identified emerging markets as “incredibly attractive.”
Beyond current market dynamics, Jody Jonsson made more of a structural case for global equities exposure:
“I think it’s a bit myopic to think that all the great companies are located in the US. Clearly, the US market has been very strong, and there are many dominant companies that are domiciled in the US. But increasingly, as you think about global champions, it doesn’t matter as much where they’re domiciled as where they do business. And in certain industries, there really aren’t even real US competitors.”
Beware of Macroeconomic Forecasts
The consensus economic outlook has been well wide of the mark lately. How long was the debate raging over whether the US economy was heading for a “hard landing” or “soft landing?” Somehow, we are still airborne. Remember when the market was anticipating seven interest-rate cuts in 2024? We were lucky to get three.
Christine and I asked Neil Shearing of Capital Economics whether this period has been especially difficult to forecast. He replied, “[T]here’s a tendency in every period to say the outlook is unusually uncertain.” Then he went on to explain that the manufacturing and services sectors of the economy diverged as a result of the pandemic, which made the economic landscape especially difficult to read. Sébastien Page of T. Rowe Price also cited the coronavirus pandemic, observing that “stimulus has distorted all the models.”
Economic forecasting is difficult. Especially over the short term, indicators like gross domestic product, inflation, and interest rates are affected by a complex interplay of variables—some unforeseen. For this reason, making big investment bets based on an economic outlook is risky. An investor who had bet against US equities and on US bonds in 2024 on expectations of recession and rate cuts would have ended up disappointed.
Big bets, in general, can backfire. Momentum is a powerful force in markets, so we could see more of the same in 2025. In that case, portfolios positioned for changes in market leadership, whether it’s bonds over stocks, small caps over large caps, or international over US equities may disappoint. Longer term, though, valuation can be a useful investment guide.
The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar's editorial policies.
