Three Surprises for 2025: Overcoming One-way Investor Sentiment

One-way Sentiment Key to Surprise Opportunities

When investor sentiment is decidedly one way, it becomes a key ingredient for capital market surprises.

As I have each January for the past nine years, I’m applying that observation — along with a focus on unloved assets with compelling valuations, where a lot of bad news is already priced in — to forecast three surprises for investors. While I’m a respectable 15 for 27 (56%) in my prediction accuracy, 27 is far too few observations to determine whether I have any forecasting skill or just dumb luck. More importantly, my brave predictions serve as an annual reminder to investors that outcomes are always highly uncertain, but a consistent, disciplined, and repeatable investment process is firmly in their control.

So, in year 10, I’ve applied my forecasting formula to identify these three surprises for 2025:

1. Health Care beats the S&P 500 Index
2. The Federal Reserve (Fed) cuts rates more than expected
3. Gold breaches $3,000

Health Care Beats the S&P 500 Index

The Health Care Select Sector Index underperformed the S&P 500 Index by a whopping 22.4% last year.² This massive performance shortfall resulted in $7.4 billion in outflows from Health Care sector exchange traded funds (ETFs) in 2024. Of the 11 economic sectors, Health Care ETFs suffered the largest outflows by a wide margin.³

According to Strategas Research Partners, the Health Care sector’s weight within the S&P 500 is flirting with a 25-year low.⁴ Over roughly the same period, total US healthcare spending has more than tripled, from $1.4 trillion in 2000 to $4.9 trillion in 2023.⁵ Yet, Americans have never been angrier about the state of the healthcare system.

All this bad news for the Health Care sector creates an unloved investment opportunity with a compelling valuation, ripe for an upside performance surprise.

The Health Care sector trades at more than a 20% price-to-earnings discount relative to the S&P 500. But, over the next three to five years it’s expected to grow its earnings-per-share (EPS) faster than the market benchmark.⁶ In a sign that investor sentiment is subtly shifting, on January 22, the percentage of stocks within the Health Care sector at 20-day highs surged to its best reading since 2023.⁷

In many respects the Health Care sector got RFK’d last year. But investors may have overreacted. Surprisingly, the Health Care sector has outperformed the S&P 500 in the first year of every Republican administration since Reagan in 1981.⁸ Further bolstering the case for a performance rebound, the Health Care sector has had the second-best outperformance relative to the S&P 500 of any sector in the first year of a presidency. Only the Financial sector has had a better record.⁹ And regarding government healthcare reform, the Trump administration’s bark may be worse than its bite.

Finally, a number of structural tailwinds could boost Health Care’s performance. Developed market economies are battling aging demographics. As a result, more money will be spent on healthcare equipment and services. With people living longer, a growing portion of healthcare spending will go toward preventive care. And, aided by artificial intelligence (AI), research will continue to develop breakthrough medicines for cancer, heart disease, and Alzheimer’s, among other illnesses.

For my first surprise, I predict that the Health Care Select Sector Index will beat the S&P 500 Index in 2025.

The Fed Cuts Rates More Than Expected

Market participants are pricing in 38 basis points (bps) of rate cuts in 2025.¹⁰ That equals about one and a half 25 bps rate cuts for the year. This suggests that while investors are confident the Fed will cut rates at least once this year, they aren’t so sure about a second rate cut in 2025. Stronger-than-expected economic data, stickier inflation, and uneasiness about the impact from future Trump administration policies have all tempered investor expectations.

Fed Chairman Powell forcefully claimed at the November 7 post-FOMC press conference that when it comes to determining the appropriate path of monetary policy, the Fed doesn’t guess, speculate, or assume what policy choices will be made by the Trump administration. But that’s exactly what the Fed did six weeks later on December 18 when it lowered the number of 2025 rate cuts from four to two in the Summary of Economic Projections (SEP).

The Fed cut rates three times in 2024, lowering the target range for the federal funds rate by 100 bps since mid-September. Curiously, both the 10-year Treasury yield and real interest rates have increased by about 100 bps since the Fed started cutting rates four months ago.¹¹ The rise in rates underscores the fact that the Fed has very little influence on the direction of long-term interest rates.

Three months after the first Fed rate cut in 1995, 2001, 2007, and 2019, interest rates fell and bond prices rose, including prices for longer maturity bonds.¹² Today’s unusual rise in rates following Fed rate cuts sparked a bout of capital market volatility beginning in early December. Sentiment and positioning suggest investors have no appetite for extending maturities in fixed income allocations.

The 10-year Treasury yield reflects growth expectations, inflation expectations, and term premium. All three have pushed rates higher since mid-September. But will it last?

The Federal Reserve Bank of Atlanta’s GDPNow estimates annual GDP growth of 3% for the fourth quarter of 2024. That is noticeably above trend growth rates. The Fed’s SEP from December 18 forecasts a much slower rate of GDP growth for 2025 — just 2.1%. It’s likely that economic growth will slow this year, putting downward pressure on yields.

Inflation May Come in Lower

Recent data releases have soothed investors’ fears of resurgent inflation. Hotter-than-expected inflation data from the first quarter of 2024 will be rolling off the year-over-year data soon. That will result in more market-friendly inflation figures in the first quarter of this year. Owners’ equivalent rent (OER) is a sizable portion of the Consumer Price Index (CPI) and it’s notoriously slow moving. OER has finally begun to show signs of cooling. The Bureau of Labor Statistics produces a New Tenant Rent Index quarterly. This indicator leads OER and it plummeted in the fourth quarter.¹³

Inflation could come in lower than expected in 2025, giving the Fed greater wiggle room to cut rates more than anticipated. At 4 ¼ - 4 ½ percent, the target range for the federal funds rate remains sizably above the Fed’s preferred measure of inflation, providing it ample room to cut rates further. If the Fed’s end game is to have a real policy rate about 100 bps above inflation, it could easily cut rates three times and by 75 bps in 2025.

US Government Financial Health Likely to Improve

The Trump administration’s proposed policies are fundamentally contradictory. Some will boost economic growth and inflation while others will curtail economic growth and be disinflationary. The timing, sequencing, size, and economic impacts are all uncertain. Fed officials should do as Chairman Powell said: don’t guess, speculate, or assume regarding future government policies.

Absent Trump policies that would further expand already irresponsible deficits, the US government’s financial health should improve this fiscal year. Individual and corporate tax revenues are likely to beat current Congressional Budget Office estimates. Entitlement program spending is slowing as inflation moderates. Rising interest costs remain a long-term challenge; but Fed rate cuts, a normal yield curve, and the probable end of quantitative tightening will give the US Treasury additional fiscal capacity.

Breaching the debt ceiling will force the government to spend down the Treasury General Account, injecting $700 billion in liquidity into the economy and easing financial conditions. All this could improve the deficit by $300-$400 billion this fiscal year, while simultaneously providing markets with some relief from rising rates and a strengthening US dollar.

For my second surprise, I predict that the Fed will cut rates at least twice this year — and possibly three or more times — in 2025.

Gold Breaches $3,000

Gold reached more than 40 all-time closing highs last year on its way to delivering a 25.5% return to investors.¹⁴ After consecutive years of strong performance combined with solid results since 2019, several sell-side research firms are bullish on gold this year.

Gold has played a critical role in both navigating drawdowns and enhancing returns in diversified investment portfolios in recent years. Gold shined during 2022. As stocks and bonds suffered double-digit losses, gold demonstrated its diversification power by maintaining its value throughout the year. Climbing about 13% in 2023, gold trailed the rebound in stocks but still notably outperformed bonds that year. Then in 2024, gold soared by 25% beating both stocks and bonds.¹⁵

So, why would gold breaching $3,000 be a surprise in 2025?

Historical headwinds for gold are expected to persist this year. Market participants are forecasting continued strength in the US dollar, a typical headwind for gold. Interest rates are likely to remain elevated and Fed watchers are anticipating fewer rate cuts this year. Because gold offers no income, higher rates can be a challenge for the yellow metal.

Following several years of strong performance, there aren’t any obvious catalysts to keep pushing gold prices higher in 2025. Gold’s industrial use in products that consumers use remains low. At loftier gold prices, jewelry demand and central bank purchases are likely to moderate. The primary driver of gold’s rise in recent years has been buying from central banks, most notably China, to diversify US dollar reserves.

Despite hitting more than 40 all-time highs last year and an annualized 5-year return of 11.5%,¹⁶ investment demand for gold remains surprisingly modest. The global ETF industry had inflows of $1.15 trillion last year, but gold ETFs added just $1.6 billion.¹⁷

Many investors continue to be skeptical about holding gold as an investment in diversified portfolios. Gold doesn’t generate income or cash flow, making it impossible for investors to calculate its intrinsic value using a discounted cash flow model. The challenge of explaining gold’s performance at times — why it does what it does when it does it — also contributes to the reluctance to incorporate gold in investment portfolios.

But the rise in the US dollar and 10-year Treasury yield may be reaching a peak. I expect both to soften during long stretches this year. Geopolitical risks and structural transitions in monetary and fiscal policies should also boost the prospects for gold. Central bank purchases throughout the year will likely continue to support gold’s price. All that could finally unleash some pent up investment demand from investors chasing last year’s record gold prices.

For my third, and final surprise, I predict that gold will breach the $3,000 milestone in 2025.

The Scars to Prove It

In the decade I’ve participated in this annual forecasting folly, I’ve often poked fun at myself and the absurdity of the whole prediction process. Don’t get me wrong, after accurately predicting 10 of 12 surprises in the first four years, there were times that I fooled myself (and maybe you) into thinking that I’m a capital markets clairvoyant.

But, over the years, I succumbed to behavioral biases, fell victim to the end of beginner’s luck, and was doomed by the law of averages. In the past five years my forecasting powers have come crashing back to earth. I’ve successfully predicted just five of 15 annual surprises since 2020. Maybe this year will be the year that I accurately predict all three, something that’s happened twice — in 2016 and 2017.

Whatever happens with this 10^th forecast, it’ll add to interesting observations I’ve made over the years. First, there’s a distinction between a surprise and a prediction. A surprise is a completely unexpected outcome. By definition, a surprise is improbable, and its occurrence is rare. It seems strange then to try to predict three of them every year. By contrast, a prediction requires conviction, analysis, and foresight. The meteorologist is confident about his ability to predict the weather over the next few days. To improve my accuracy, maybe I shouldn’t be chasing infrequent surprises, but rather making confident predictions.

Second, constraining the forecast period to the calendar year is arbitrary. I’ve observed that sometimes a surprise prediction that didn’t work in the calendar year, was accurate in the following calendar year. Value-oriented investors are often early in recognizing an opportunity and patience is required for the investment to become profitable. Last year I accurately predicted that high yield bonds would repeat as a top bond market performer. But my other two surprises — biotech and real estate — missed the mark. If history repeats itself, investors may want to keep an eye out for signs of life from biotech and real estate investments this year.

In the end, I hope the enduring lesson learned from this decade-long exercise is that investment outcomes are extraordinarily uncertain. And the application of a consistent, disciplined, and repeatable investment process provides investors the best opportunity to reach their long-term financial goals.

May all investors be pleasantly surprised again in 2025.

For institutional / professional investors use only.

View More Information About Our Firm: FINRA's BrokerCheck

Investing involves risk including the risk of loss of principal. The whole or any part of this work may not be reproduced, copied or transmitted or any of its contents disclosed to third parties without SSGA’s express written consent.

ETFs trade like stocks, are subject to investment risk, fluctuate in market value and may trade at prices above or below the ETFs net asset value. Brokerage commissions and ETF expenses will reduce returns.

The S&P 500® Index is a product of S&P Dow Jones Indices LLC or its affiliates (“S&P DJI”) and have been licensed for use by State Street Global Advisors. S&P®, SPDR®, S&P 500®, US 500 and the 500 are trademarks of Standard & Poor’s Financial Services LLC (“S&P”); Dow Jones® is a registered trademark of Dow Jones Trademark Holdings LLC (“Dow Jones”) and has been licensed for use by S&P Dow Jones Indices; and these trademarks have been licensed for use by S&P DJI and sublicensed for certain purposes by State Street Global Advisors. The fund is not sponsored, endorsed, sold or promoted by S&P DJI, Dow Jones, S&P, their respective affiliates, and none of such parties make any representation regarding the advisability of investing in such product(s) nor do they have any liability for any errors, omissions, or interruptions of these indices.

Distributor: State Street Global Advisors Funds Distributors, LLC, member FINRA, SIPC, an indirect wholly owned subsidiary of State Street Corporation. References to State Street may include State Street Corporation and its affiliates. Certain State Street affiliates provide services and receive fees from the SPDR ETFs. ALPS Distributors, Inc., member FINRA, is the distributor for DIA, MDY and SPY, all unit investment trusts. ALPS Portfolio Solutions Distributor, Inc., member FINRA, is the distributor for Select Sector SPDRs. ALPS Distributors, Inc. and ALPS Portfolio Solutions Distributor, Inc. are not affiliated with State Street Global Advisors Funds Distributors, LLC.

THIS SITE IS INTENDED FOR QUALIFIED INVESTORS ONLY.

No Offer/Local Restrictions

Nothing contained in or on the Site should be construed as a solicitation of an offer to buy or offer, or recommendation, to acquire or dispose of any security, commodity, investment or to engage in any other transaction. SSGA Intermediary Business offers a number of products and services designed specifically for various categories of investors. Not all products will be available to all investors. The information provided on the Site is not intended for distribution to, or use by, any person or entity in any jurisdiction or country where such distribution or use would be contrary to law or regulation.

The information provided does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor's particular investment objectives, strategies, tax status or investment horizon. You should consult your tax and financial advisor. All material has been obtained from sources believed to be reliable. There is no representation or warranty as to the accuracy of the information and State Street shall have no liability for decisions based on such information.

All persons and entities accessing the Site do so on their own initiative and are responsible for compliance with applicable local laws and regulations. The Site is not directed to any person in any jurisdiction where the publication or availability of the Site is prohibited, by reason of that person's nationality, residence or otherwise. Persons under these restrictions must not access the Site.

Information for Non-U.S. Investors:

The products and services described on this web site are intended to be made available only to persons in the United States or as otherwise qualified and permissible under local law. The information on this web site is only for such persons. Nothing on this web site shall be considered a solicitation to buy or an offer to sell a security to any person in any jurisdiction where such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction.

Before investing, consider the funds' investment objectives, risks, charges and expenses. To obtain a prospectus or summary prospectus which contains this and other information, call 1-866-787-2257 for ETFs, 1-877-521-4083 for cash funds, 1-800-242-0134 for ELFUN, or 1-800-997-7327 for institutional services, download a prospectus or summary prospectus now, or talk to your financial advisor. Read it carefully before investing.

Not FDIC Insured * No Bank Guarantee * May Lose Value

AdTrax Code: 6729648.2.1.AM.INST

Expiration Date: 30 June 2025

© State Street Global Advisors

More Innovative ETFs Topics >