The S&P 500's Recovery: What History Might Predict for 2025

The stock market recovery has shown some unevenness, but signs suggest that this might soon change.

The S&P 500 (^GSPC 0.39%) saw substantial recovery since it reached a low point in October 2022. Over the past 27 months, this significant stock index has climbed around 69%. However, many investors may have noticed their individual portfolios lagging behind this impressive benchmark, primarily due to a trend that hasn’t been seen in over four decades.

In 2024, only 28% of stocks within the S&P 500 outperformed the index itself. This figure is among the lowest recorded since 1980. The only year that saw fewer stocks beating the index was 2023, when just 27% managed to do so.

With just a select few stocks driving higher returns, investors who haven’t been invested in the top-performing stocks over the last 27 months may find themselves at a disadvantage. The S&P 500 is now more weighted towards its top 10 stocks than at any other time in its history. If historical trends are any guide, this concentration could precede significant market movements in 2025.

What Can History Teach Us?

A market where only a small number of stocks outperform the S&P 500 often indicates an increase in market concentration. The last time such a limited number of stocks propelled the index was during the years 1998 and 1999.

In the years that followed, two major events occurred:

Firstly, the index peaked in early 2000, marking the start of the notorious dot-com bubble burst, which severely impacted overvalued tech stocks. The S&P 500 lost half its value by October 2002, and during the same time, the Nasdaq Composite Index plummeted by 78% from its peak to its lowest point. Analysts are currently cautious about future returns from the S&P 500 due to this concentration and the lofty valuations of the leading companies.

However, the second noteworthy observation is that many S&P 500 stocks actually outperformed the index during the downturn. Over 60% of the S&P 500 components did better than the index in the years 2000, 2001, and 2002, and many continued to show robust performances through 2005. This suggests a reversal of trends, allowing the market to broaden out.

Could We See a Trend Reversal in 2025?

Forecasting whether the market will regain balance or if a downturn is inevitable in the coming years is challenging. Still, there are indicators suggesting that we might see a change by 2025, particularly given the record levels of concentration currently observed.

The monetary supply in the U.S. is growing at an accelerating pace. With the Federal Reserve aiming to lower interest rates, we could witness a more stable money supply growth, a key indicator that suggests a potential market broadening. Economically speaking, when cash becomes easier to access, smaller companies typically find it easier to invest and expand. Presently, the top companies hold significant cash reserves, enabling them to invest heavily in advancements such as artificial intelligence (AI).

Nevertheless, the Federal Reserve seeks clearer signs of diminishing inflation before continuing to cut rates. Current trade policies may exacerbate inflation, so the effects of tariffs and other measures remain to be seen.

For long-term investors concerned about the high concentration of the market and the possibility of a trend change, there is an uncomplicated strategy to consider.

A Simple Method to Enhance Your Investment Strategy

If you believe that the current situation will shift from a few stocks outperforming the S&P 500 to the majority of stocks doing better, one effective option is to consider an exchange-traded fund (ETF). An example is the Invesco S&P 500 Equal Weight ETF (RSP 0.49%).

This equal-weight ETF purchases an equal dollar amount of each stock in the S&P 500. This approach means that instead of the top five companies on the index being nearly 27% of its total value, they collectively represent just about 1%, equal to the smallest five companies in the index. The fund undergoes rebalancing every quarter to account for any new additions and removals in the S&P 500.

When a broader selection of stocks outperforms the overall index, the equal-weight index typically excels. Historical data shows that during the period from 2000 to 2005, while the S&P 500 yielded a total return of -6.6%, the equal-weight index produced a remarkable 59.2% return.

The Invesco index fund is a well-regarded choice for investing in the equal-weight S&P 500 index, offering a low expense ratio of 0.2% and refraining from passing capital gains onto shareholders since its inception, thus avoiding tax burden on the investment.

Generally, the equal-weight index tends to outperform its market-capitalization-weighted counterpart over the long run, as smaller companies often have greater growth potential compared to larger firms. Although it hasn’t seen success recently, now may be an opportune time to invest in an ETF that tracks the equal-weight index before any trend shifts occur.

stocks, market, investing