Back-to-back years of nearly 25% gains for the big-cap S&P 500 raises the bar for stock mutual funds in 2025. But with the AI build-out still in its early days and both the economy and consumers showing resilience, don’t bet against a three-peat.
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“Many of the trends that have been driving the markets will remain,” said Shilpa Mehra, manager of $4.1 billion Fidelity Trend (FTRNX), which is up 43% in 2024, topping 96% of its large-growth fund peers.
Still, like most years, the 2025 market outlook isn’t risk-free. The S&P 500, up more than 24% this year thanks to the start of the Federal Reserve rate-cut cycle and AI boom, after a 24.2% gain in 2023, faces headwinds. For one, stocks aren’t selling at bargain-basement prices. “Valuations are full,” said Mehra. “Stocks are not cheap.”
2024: A Year To Remember For Mutual Funds
In 2024, the tech-filled Nasdaq is leading the performance derby, rising 30.4%. The Dow Jones Industrial Average is up 13.7%, and the small-cap Russell 2000 is lagging with a gain of 10.6%. Mutual fund investors have been rewarded, with the average U.S. diversified equity fund posting a 23.5% gain through the end of November, according to Lipper Refinitiv data.
In the new year, though, investors will also be closely watching how the Trump administration’s growth-focused polices and plans to slap tariffs on goods entering the U.S. will impact inflation and Federal Reserve interest rate policy.
Uncertainty pertaining to tariffs is likely to boost market volatility. “How they implement tariffs could lead to market downside and a market shock,” said Ankur Crawford, co-manager of $2.1 billion Alger Focus Equity (ALGRX).
Mutual Funds Monitor The Fed
The Fed cut its key borrowing rate by a quarter point to 4.25% to 4.5% in December. But the central bank also gave investors pause with a hawkish outlook. The Fed dialed back its rate-cut expectations for 2025 to two quarter-point cuts, down from four forecast cuts in September.
In response, the yield on the 10-year Treasury note has reset higher to around 4.5%. That’s up nearly a full percentage point since the low in mid-September when investors were betting on a weaker economic outlook that didn’t materialize.
What’s Coming For 2025
Where the stock market goes in 2025 is anyone’s guess. But every year there are always stock market winners. Many portfolio managers are saying fund performance next year will be driven by stock picking. So, Investor’s Business Daily talked with managers of 2024’s top-performing mutual funds to get their take on which stocks could prosper in 2025.
There’s no better financial action plan than researching stocks with potential upside that can help build portfolio account balances and long-term wealth.
Invest In AI And Innovation
AI is not an undiscovered investment theme. The list of S&P 500’s top performers in 2024 is filled with AI-powered stocks.
AI software and analytics company Palantir (PLTR) is No. 1 and has posted a total return of 369.1% this year as of Dec. 20. Independent power producers (IPPs), such as Vistra (VST) (up 265.6%) and Constellation Energy (CEG) (up 95.4%) are surging on AI data center energy demand.
AI chipmaker Nvidia (NVDA) continues to shine with a 172.1% gain, as does newest AI semiconductor darling Broadcom (AVGO), up 99.2% in 2024. Texas Pacific Land (TPL), which owns nearly 900,000 acres of land in West Texas, is up 119.1% as its land is seen as a key location for the AI data center build-out.
But the runway remains long for AI stocks as it drives productivity within the economy, fund managers say.
“I think tech is well-positioned to continue to outperform,” said Tony Wang, manager of $10.8 billion T. Rowe Price Science & Technology (PRSCX), which has gained 42.3% this year, topping 92% of its tech fund peers. “I’m pretty optimistic that the competitive advantages of tech continues.”
AI Has More Room To Run
Wang likes software companies Microsoft (MSFT), which he says is priced right now as it has lagged in 2024 with a 16.1% gain. He also likes ServiceNow (NOW), which is using AI to improve companies’ digital workflows and has gained 54.5% in 2024.
When it comes to AI, there are direct plays like chipmakers or AI software companies. But there are also indirect beneficiaries like energy companies that power the data centers and landowners who can provide acreage for new AI data center locations.
“We’re at the very early stages of this huge new (AI) mega theme,” said Patrick Kelly, the other co-manager of Alger Focus Equity, which is up 53.7% this year, topping 99% of its large growth fund peers.
“We want to be positioned in companies that are benefiting from all this change and innovation and are on the right side of these secular themes,” said Kelly. “We want to avoid many of the traditional business models that are coming under pressure from AI.”
Upgrading The Economy
AI will infiltrate the U.S. economy in many different ways, creating AI investment opportunities in different types of companies, says Alger’s Crawford.
One group Crawford is bullish on is IPPs, such as Constellation Energy (CEG), Vistra (VST) and Talen Energy (TLN). “They are the beneficiaries of a power shortage in the U.S. because of (energy-eating) data centers,” said Crawford. IPPs benefit from AI-driven energy demand.
Nuclear power player Constellation Energy, for example, recently inked a 20-year power purchase deal with Microsoft. Similarly, Amazon.com (AMZN) looked to ink a similar-type deal with nuclear company Talen Energy (TLN) but ran into regulatory obstacles. Still, Crawford sees more of these types of deals going forward.
“That effectively causes an (upward) re-rating to not only to earnings, but to the earnings multiple the market’s willing to pay for these companies,” said Crawford.
AI’s Key To The Stock Market
Kelly sees continued upside in stocks benefiting from AI because of their ability to increase revenues and earnings. That powers price-earnings multiple expansion as well.
AI stocks also can grow their market share in their area of expertise. “You still have this backdrop of all this innovation and all of these secular investment themes,” said Kelly. “Who’s on the right side of it and who’s on the wrong side of it will continue to be a big driver of returns.”
Kelly says one stock benefiting from AI is AppLovin (APP), an advertising tech company best known for using AI to provide targeted ads on mobile games. The company’s shares have soared 756% this year.
“They have an audience of 1.4 billion daily active users,” said Kelly. The upside to AppLovin, which was a top-10 holding for the fund at the end of September, according to Morningstar, is they are now expanding beyond mobile gaming into the e-commerce market, says Kelly. “The stock is up, and the move would not have been possible without AI,” said Kelly. “Despite the move, we remain positive and bullish on the company going forward.”
Buy Niche Stock Mutual Funds Stories In Up Cycles
Everybody knows about the Magnificent Seven tech stocks that have been leading the markets higher for the past few years. Seeking stock market winners in less-picked-over corners of the market offers fresh opportunities, says Fidelity’s Mehra.
“You need to find niche stories, companies that are doing cool things, and that are in up cycles,” said Mehra.
Take commercial aerospace, for example. Airlines are filling seats at a record pace this holiday season, building on an already strong year of bookings.
“Travel is back,” said Mehra. “There’s a lot of demand and we don’t have enough airplanes because of Boeing’s (BA) (production and safety) issues. So, a lot of the providers in the commercial aerospace area have seen really great pricing power.”
Another less publicized stock Mehra likes is Axon Enterprise (AXON), a public safety company. Axon makes and sells less lethal defense weapons such as Tasers, as well as bodycams and dashcams used by law enforcement. “It’s a really high-quality business,” said Mehra. “They have a few new AI products that help police officers do their day jobs. And Axon is expanding internationally.”
Diversify With Small- and Mid-Cap Names
Companies with small and midsize market caps lagged their big-cap brethren in 2024. But that doesn’t mean they can’t close the performance gap in the new year, says Ryan Kelley, a co-manager of Hennessy Cornerstone Growth (HFCGX). It’s a small-cap fund that has topped 99% of its peers with a gain of 32.2% in 2024. Kelley also manages the $1. 8 billion Hennessy Cornerstone Mid Cap 30 (HFMDX), which has rallied 36.3%, putting it in the top 1% of mid-cap stock fund performance.
Kelley says small caps could benefit from large-cap stocks taking a breather. Another plus is he expects the market to broaden out beyond the tech sector. And small-cap indexes like the Russell 2000 have smaller tech exposure and are more broadly represented by sectors, such as financials, industrials and consumer discretionary.
“It’s not just large versus small,” said Kelley. “It’s more about different sectors doing well.”
Kelley’s funds use a quantitative approach to identify small stocks with low price-to-sales ratios that have positive price momentum over the past three and six months periods. “We’re buying companies that have already turned the corner,” said Kelley. “Six-month (stock price) momentum is one of the stronger predictors of longer-term performance. We end up getting a lot of turnaround stories with our model.”
Follow Your Discipline With Mutual Funds
Smaller stocks don’t get the publicity of popular stocks like Nvidia and Apple (AAPL), nor are they covered as intently by Wall Street analysts.
One small stock Kelley’s bullish on is Sprouts Farmers Market (SFM), a grocery known for its natural and organic foods. “Sprouts is not a turnaround, it is a health-food conscious grocery store that continues to grow and take market share,” said Kelley.
A stock in turnaround mode that Kelley likes is Peloton Interactive (PTON), the fitness company known for its stationary bikes and treadmills. The stock, which soared during the Covid-19 pandemic but then saw sales stall, is in comeback mode. Shares are up 54% this year as investors react to new CEO Peter Stern that took over in October, cost-cutting, and the company boosting its fiscal-year 2025 earnings guidance.
Other smaller stocks mounting comebacks that Hennessy funds own include restaurant chain Brinker International (EAT), which is benefiting from a resurgence at Chili’s and is up 210.9% this year. Another is Alaska Air Group (ALK), up 69% in 2024, and which recently unveiled a three-year strategic plan to generated $1 billion in incremental profit following its merger with Hawaiian Airlines.
Bond Mutual Funds Investors Shouldn’t Go Long
With the 10-year Treasury yielding around 4.5% and the Fed on track for fewer rate cuts in 2025, it’s a perfect time for bond investors to take advantage of yields that are about two percentage points higher than inflation, says Matt Eagan, a fixed-income portfolio manager and head of the full discretion team at Loomis Sayles.
“You’re getting a real yield of around 2%, which from an historical perspective is pretty attractive,” said Eagan. “You’re also getting compensated for a decent amount of risk.”
Eagan prefers intermediate bonds with maturities of five to seven years, and advises bond investors to avoid long-term bonds like the 30-year Treasury as they will be more vulnerable if inflation continues to surprise to the upside, says Eagan.
