U.S. equities: Climbing the valuation wall

Investors enter 2025 with cautious optimism following a stellar 2024 for equities, as stretched valuations and elevated bond yields pose near-term challenges. Despite these potential headwinds, strong earnings growth remains the driver of market performance—if earnings deliver as expected, equities are likely to remain biased higher.

The S&P 500 reached an impressive 57 all-time highs in 2024, reflecting the resilience and optimism of the current bull market. Historically, such milestones are not uncommon during periods of strong market momentum and do not necessarily signal an impending downturn. However, as valuations for U.S. equities soar to near unprecedented levels, earnings must deliver against lofty expectations.

Looking ahead to 2025, the earnings outlook appears promising, supported by a constructive U.S. economic environment. Policy developments from the new administration—focused on deregulation and tax reductions—could provide additional tailwinds for growth. Yet, rising bond yields present a significant challenge. If yields continue climbing, equity markets may face heightened volatility, as even modest increases in rate expectations could temper gains.

Another area of concern is the concentrated outperformance of the "Magnificent 7." While these leading companies are expected to benefit from long-term secular growth trends, their stretched valuations, coupled with elevated yields, highlight the importance of diversifying into stocks with more attractive valuations. Encouragingly, the strong macro backdrop supports robust earnings growth across a broad spectrum of sectors, cap sizes, and economically sensitive companies. These segments, trading at more reasonable multiples, could offer compelling opportunities in the year ahead.

With stretched equity valuations and elevated bond yields, investors may be cautious after such a strong year in 2024. However, provided earnings growth remains strong, equities are likely still biased higher in 2025.