CIO Outlook: After Two Remarkable Market Years, What’s Next for Stocks?

Dear Hennessy Funds Shareholder,

As we enter 2025, I wanted to share some of our views on the market and what may lie ahead.

In 2024, the stock market experienced exceptional performance with broad-based equity indexes having above-average, double-digit returns. On a total return basis, the Dow Jones Industrial Average rose nearly 15%, the S&P 500® Index increased 25%, and the Nasdaq Composite Index surged nearly 30% in the year.

Last year was the second in a row that the S&P 500 rose by over 20%, which is uncommon. This has only happened three other times since the index began in 1957. Over the past 100 years, the Dow, which has a much longer history than the S&P 500, has had two consecutive 20%+ annual returns a total of nine times. Yet, we find no strong correlation to help investors predict what happens in the third year. While the median return is 2% in year three on those nine occasions, the range varies greatly: in 1937, the Dow fell 33%, and in 1997, the Dow rose 25%.

A primary driver of strong market performance in 2024 was the anticipation and resumption of interest rate cuts by the Federal Reserve as inflation declined. The Consumer Price Index (CPI), a measure of inflation, dropped from the 5 - 6% range two years ago to 2.5 - 3% more recently.

In addition, investors were immediately relieved that the presidential election results were decisive and not contested. With the new administration, there is an expectation that the economic environment will improve with potentially less stringent regulations in certain industries, including financials, energy, and utilities. In addition, a potential reduction in corporate tax rates across the board could be a significant positive for stocks, and any reduction of individual tax rates could be a plus as well.

On the other hand, we could see increased stock market volatility due to increasing geopolitical tensions and associated uncertainty. The effects of increased tariffs and potential deportations could hurt the U.S. consumer as well as certain companies and sectors of the economy. With tariffs, fewer workers, and more restrictive global markets, there could be issues resulting in higher costs, labor shortages, and supply chain disruptions.

Over 2023 and 2024, the “Magnificent Seven” stocks—Google parent Alphabet, Amazon.com, Apple, Meta Platforms, Microsoft, Nvidia, and Tesla—dominated overall market performance. In 2023, close to 60% of the S&P 500’s performance came from these seven stocks, and, in 2024, about half was driven by the same “Magnificent Seven.” Conversely, that means that about half of the S&P 500’s performance was from the other 493 stocks in the index in 2024.

In 2025, we anticipate increased volatility for the overall market and perhaps relatively stronger performance from certain areas of the market other than the “Magnificent Seven.” Small and mid-cap stocks may perform better than their larger counterparts as they are more evenly diversified across different sectors of the economy. In addition, the potential for continued rate cuts, less regulation, and a lower corporate tax rate could disproportionately benefit small-caps, mid-caps, and domestically focused companies.

We also see opportunities in certain sectors, including those that have done well in 2024, such as financials, as well as some that have lagged, such as energy.

•  Financials. 2025 could be another good year for financials after a very strong 2024 given the resumption of interest rate cuts, the reduction in short-term rates creating a non-inverted yield curve, and incremental loan growth. In addition, any relaxation of regulations that have been constrictive to the industry for over a decade will also be beneficial. The industry had been out of favor for many years prior to 2024, with valuations at a deep discount to the overall market. Given financials’ strong balance sheets, solid asset quality, and improving profitability, along with an improving interest rate environment and the potential for P/E expansion, earnings growth, and increased M&A, we think financials are an attractive sector in which to be invested in 2025.

•  Energy. We view the energy sector as a long-term growth industry for potentially several decades. Global population growth and the pursuit of improved standards of living are driving the need for all forms of energy. Growth in artificial intelligence (AI) and data centers demands more energy, and the onshoring of manufacturing should continue to prop up domestic energy needs. Additionally, the transition to cleaner forms of energy is driving investment opportunities across traditional energy and renewable energy value chains, creating opportunity for investors. Finally, we believe corporate energy management teams are more aligned with shareholders than at any time in the past, prioritizing shareholder returns above absolute growth objectives.

•  International. Given some concern about U.S. valuations following strong 2023-2024 returns, it may make sense for investors to diversify their portfolio outside the U.S. The Japanese equity market has always included high-quality companies, but now a confluence of macro factors has made the portfolio managers at SPARX Asset Management (the sub-advisors of our two Japan funds) even more bullish. Government initiatives have encouraged companies to become more shareholder friendly. The Tokyo Stock Exchange introduced an initiative to drive better governance, a focus on stronger returns, and higher valuations from companies that trade below book value. Inflation and wage growth should start to drive a stronger consumer in Japan. Lastly, Japanese investors are beginning to put more money into their own market. With most household financial assets in bank accounts earning little-to-no interest, Japanese individuals may be incentivized to invest more in the domestic stock market. These reasons provide a compelling bull case for Japanese equities.

Regardless of what unfolds in 2025, we encourage you to stay invested, maintain a diversified portfolio, and keep a long-term perspective. Hennessy Funds offers high-conviction portfolios, time-tested investment approaches, and long-tenured management teams. We invest with optimism while always being mindful of downside risk, as we’d rather make less money for our shareholders in up markets than lose money in down markets.

We thank you for your ongoing trust and interest in the Hennessy Funds. We are grateful that you have selected to invest in our Funds for a portion of your diversified portfolio. Should you have any questions or wish to speak with us directly, please give us a call at (800) 966-4354.

Best regards,