As we transition into 2025, U.S. investors are keen to understand how the stock market may unfold. With Republicans now in control of the White House, Senate, and House of Representatives, and after a robust two-year run of nearly 20 percent annual gains in 2023 and 2024, questions arise about what history suggests for the coming year
Most years, for as long as I can remember, I toss the “Stock Trader’s Almanac” into my dad’s bag of Christmas gifts. The publisher’s website explains, “For over five decades, top traders, investors, and money managers have relied upon Stock Trader’s Almanac. The 2025, 58th Annual Edition shows you the cycles, trends, and patterns you need to know to trade or invest with reduced risk and for maximum profit.”
I buy one for myself too (although the publisher does give it away for free if you subscribe to their service). I enjoy the book because it is full of historical data. That can be important to investors because while history does not necessarily repeat, it does rhyme. I find it helpful to consider what has happened in the past to determine what may happen. I have extracted some of the Almanac’s concepts below and augmented them with other historical data to sketch out what we might expect from the stock market in 2025.
1. A year following consecutive market gains
Markets that rally strongly for two consecutive years often face increased risks of correction or consolidation. Historically, when the stock market has risen 20 percent or more for two years straight, the following year usually shows muted gains or declines due to profit-taking, valuation concerns, and shifting economic conditions.
- Historical Precedent: After consecutive strong years, there is a 70 percent probability of a market pullback or correction of at least 10 percent within the following year.
- Political Influence: Republican-led administrations, while often pro-business, may prioritize fiscal tightening or regulatory shifts that can temporarily disrupt equity markets. Fiscal policy has been discussed widely but only narrowly defined; I will keep track of this for you.
2. When to expect a 10 percent decline
Based on historical tendencies, corrections of at least 10 percent are not uncommon after prolonged rallies. Key periods to monitor include:
- Mid-Year Volatility: June and September have historically been weaker months during post-election years.
- Trigger Events: Corrections are often linked to Federal Reserve decisions, inflation concerns, or geopolitical tensions. The Fed could pause cutting interest rates at a level much higher than expected, which could trigger a pullback.
- Probability: Post-election years experience corrections 70 percent of the time, with the S&P 500 typically declining by 10 percent to 15 percent at least once.
3. The “January Effect” and “Barometer”
The “January Effect” and the “January Barometer” remain critical indicators:
- First Five Days: Positive returns in the first five trading days have historically signaled full-year gains 83.3 percent of the time. After two years of strong growth, however, the accuracy rate slightly decreases.
- Down Januarys: If January posts a loss, the likelihood of a full-year decline or correction rises significantly.
4. Sector strength and rotation
If the stock market swoons more than a garden-variety correction in 2025, sector performance may reflect a shift toward defensive plays. Currently, I do not expect anything significant, and the status quo is mainly the plan.
- Defensive Sectors: Utilities and consumer staples would likely outperform in a cooling market. Utilities are a double threat: If the economy picks up significantly, there is demand for their products; if the economy hits a wall, investors seek the companies’ yield. Healthcare is traditionally included in that list, but federal regulation may be a headwind this year.
- Technology Slowdown: After two years of substantial growth, technology and growth stocks may face valuation pressures. That is an example of a 2025 threat, although the long-term exposure to tech stocks (especially the “hyper-scalers”) should be a core part of investment portfolios.
- Small-Caps: The “January Effect” traditionally benefits small-cap stocks, but caution is warranted after extended bull runs. While exposure is warranted in growth-oriented portfolios, moderation is risk mitigation.
5. Federal Reserve and economic indicators
The Federal Reserve’s policy will play a pivotal role in shaping market dynamics:
- Interest Rates: Continued monetary tightening could weigh on equity valuations (interest rates are coming down, but they are still in a restrictive zone). However, a pivot to more interest rate cuts than expected might spark renewed optimism.
- Inflation Trends: Persistent inflation may pressure corporate earnings, while declining inflation could provide relief to growth sectors. I expect inflation to continue its downward trend.
6. Geopolitical and macro risks
The interplay of global events and domestic policy changes could elevate risks:
- Trade Tensions: U.S.-China relations remain a wildcard that could impact supply chains and market sentiment. President-elect Donald Trump’s invitation to China’s President Xi Jinping, whether he attends or not, signals thawing relations. One of the best strategies to keep inflation low would be if the two nations kissed and made up.
- Geopolitical Uncertainty: Conflicts or disruptions in key regions may lead to market volatility.
7. Lessons from 2023 and 2024
Reflecting on the last two years provides valuable context for 2025:
- Bears Turning to Bulls: Many analysts who were bearish during the early 2020s have shifted to bullish stances after underestimating the market’s resilience and growth potential. This sentiment shift often supports continued market momentum—until it doesn’t (see No. 9).
- Artificial Intelligence as a Growth Driver: AI has emerged as a transformative technology, driving innovation and productivity gains across industries. While some skeptics attribute recent market growth to AI hype, its long-term potential could sustain earnings growth in 2025. As a user of many AI tools, I am a big believer in their power to positively transform corporate processes and profitability.
8. The role of small- and mid-cap stocks
Small- and mid-cap stocks have shown renewed strength, particularly in late 2024. Historical data suggests that when small caps gain more than 10 percent in a month, as they did in November 2024, the following six months often see continued gains. Mid-cap stocks, benefiting from economic growth and deregulation under Republican leadership, may also outperform.
9. Sentiment and momentum
Investor sentiment and momentum indicators remain key to understanding market trends.
- Excessive Optimism: Sentiment surveys and low volatility measures, such as a subdued VIX, indicate a potentially overheated market. A sentiment-driven pullback could occur early in 2025. I will be looking for extreme bullish sentiment of the crowd as a signal to pull in bullish horns.
10. Actionable steps for 2025
To navigate the uncertainties of 2025, investors should consider the following strategies:
- Prepare for Corrections: Don’t be too concerned if you are sitting on cash reserves even as the stock market has roared. Historical data suggests corrections are likely after consecutive strong years. But if you have not invested in the market when it has been going up, are you prepared to capitalize on opportunities during market pullbacks? Make a plan or set a limit order for the investments on your radar.
- Diversify Defensively: I have been very light on direct foreign equity exposure for quite some time, and I am not ready to go there yet. For most of 2024, I invested in small-cap stocks using a hedged strategy. In November 2024, I added direct exposure and went into 2025 with an allocation. Utilities are also becoming attractive as a high-yielding defensive sector to weather potential downturns and provide correlative exposure to economic growth.
- Monitor Key Indicators: Pay close attention to January’s performance, Federal Reserve announcements, and geopolitical developments (especially with China) to adjust strategies as needed.
Conclusion: What’s past is prologue, but…
If you can look into the seeds of time and say which grain will grow and which will not, speak then unto me.
The stock market in 2025 presents a mix of opportunities and challenges, with historical patterns suggesting a high probability of a correction following two years of substantial gains. My highest conviction forecast for 2025 is a 10 to 15 percent correction. My second-highest-conviction prediction is the transformative nature of artificial intelligence.
You will not find anything about AI in the “Stock Trader’s Almanac.” Even if AI is not in the headlines as much as in 2024, it will play a massive role in making companies more profitable. However, that effect on profitability may be more of a 2020s story than a 2025 story. I am an early adopter, so I recognize its benefits. Still, email, for example, was first introduced in 1971 via ARPANET. IBM PROFS made it available commercially in 1981 (and others, too, around that time). During the 1980s and 1990s, the use of email became more common in business, government, universities, and the military. Email did not become ubiquitous until the early 2000s, 50 years later.
Given the history of email, it may seem that the benefits of AI are too far away to make an impact. However, our adoption rate is quickening as the U.S. population becomes more technologically savvy. For example, Apple introduced the smartphone in 2007 and sold 1 million iPhones in its first 74 days. They sold 231 million iPhones in 2023. And while I am an Apple user, Samsung undeniably makes a smarter smartphone; by 2019, they sold 2 billion smartphones.
Careful readers of “Capital Ideas” will remember me citing that the first examples of AI were from the 1950s. In 1997, Deep Blue, IBM’s AI, beat chess champion Gary Kasparov. Just because it has only recently become popular in the stock market does not mean it is a new phenomenon. And even though history is a guide for making positive decisions about the future, we should not forget to think about the future when considering the future! That being said, although it will be painful at the time, we should root for a 10 to 15 percent pullback so that conservative investors can get some cash to work.
