Stock investing insights to start the new year

Thoughts from Tony DeSpirito, CIO of U.S. Fundamental Equities, Blackrock

What’s in store for stocks after two years of strong returns? Fundamental Equities Global CIO Tony DeSpirito assesses the prospects for another positive year and offers his year-ahead outlook through the lens of an active stock picker.

BlackRock’s Tony DeSpirito recently appeared on The Bid podcast with a “Stock Picker’s Guide to 2025.” He discussed whether stocks can keep up the strong performance they’ve delivered for two years running and dug into topics driving the market (like AI) and those flying beneath the radar (value stocks). Here we offer highlights of the broader conversation with The Bid host Oscar Pulido.

The big picture

Mr. DeSpirito is optimistic that stocks can notch a positive year ― even if not touching the spectacular levels of 2023 and 2024. He notes that three consecutive years of 20%+ returns are very rare, but as discussed in his Q1 market outlook, the market and economic pieces appear well placed for stocks to deliver positive returns consistent with their long-run average.

What is he watching?

For one, inflation. Mr. DeSpirito says the Fed has done a “remarkable job” by bringing inflation down without triggering a recession. But he cautions not to check it off your worry list.

“Inflation is not yet down to the targeted rate, so there’s still more to go. And that last mile, so to speak, is awfully tough.” Mr. DeSpirito cites policy around immigration and tariffs as potential inflation risks, “depending how they’re implemented,” and looks to historical research for patterns in inflation:

“If you look over history, whenever we’ve hit a big wave of inflation, it’s usually been followed by a second wave roughly within two years. And so that’s the base rate that we’re dealing with.” The bottom line: Inflation looks good for now, but it does warrant continuous attention.

Closely tied to inflation is interest rates, and here 2024 presented an anomaly: While the 10-year Treasury yield increased over the course of the year, stock market multiples expanded. Typically, as in 2022, higher rates are a headwind for stocks. This is another variable Mr. DeSpirito has his eye on.

What has the veteran investor excited? Mega forces, which he sees as important drivers of investment returns going forward and a particular opportunity for active stock pickers. “When I hear ‘mega forces’ … what I hear is ‘change,’” he says, “and I view that as a real positive for active investors because that’s what we’re good at … being nimble, being active, adapting.” Mega forces, whether digital disruption, demographics, future of finance, he says, do not evolve in a straight line. “There’s going to be puts and takes along the way, and that’s where we come in as active investors.”

When I hear ‘mega forces’ what I hear is ‘change.’

And I view that as a real positive for active investors.

Hot topic: Artificial intelligence (AI)

Chief among the mega forces is digital disruption and AI, which has powered the lion’s share of returns over the past two years. Mr. DeSpirito and his team are continually mining for the next layer of beneficiaries.

“I don’t think this is an area where you want to set it and forget it,” he says. “There’s going to be lots of shifts, lots of changes. I think you need to stay nimble. So, I certainly think of AI as a huge opportunity for active equity investors.”

The initial phase of AI development and investment centered on hardware. High-profile semiconductor names and cloud service providers have been the primary beneficiaries, but Mr. DeSpirito sees the opportunity set expanding.

“There’s been a huge boom in power companies. Why? Because AI requires a lot of power to operate.” This has benefited independent power producers and the equipment companies that supply to them and to the data centers. Look for this to broaden out, he says.

The initial AI models were mostly publicly available large language models (LLMs). Mr. DeSpirito sees this evolving toward “more narrowly tailored, smaller models that are more efficient, but that are very much focused on certain verticals.” He’s looking for winners and losers in this space. Likewise in data and in software, where some will be replaced by AI and others enhanced by it.

Underappreciated topic: Value investing

While AI and growth stocks more generally have commanded the spotlight, below the surface is an opportunity in value stocks, according to Mr. DeSpirito, who is a long-time value investor himself.

Value stocks, by definition, trade at levels below their intrinsic worth. The market has underpriced them for one reason or another. In a world where indexes are stretched, Mr. DeSpirito sees value stocks as an attractive offset.

The price-to-earnings multiple of the S&P 500 is near its all-time high. Value stocks are always an antidote to that, he says, but they are a particularly potent one today with the discount being wide relative to historical averages.

Mr. DeSpirito also sees value stocks as an antidote for index concentration: “If you look at the top three stocks in the S&P 500, they now make up 20% of the index. That’s a record. If you look at the Russell 1000 Value Index, the top three stocks in that index make up only 8%.”

The same is true of sector concentration, where tech dominates in the S&P 500 but represents a much smaller share in the value space, where the largest sector is financials. The upshot: A diversification benefit.

Finally, he says, assuming you aimed to balance your portfolio at 50% growth/50% value, the fact that growth stocks have powered ahead over the last two years means your portfolio is misaligned from your original setting.

Even core indexes like the S&P 500 have become more growthy of late, a topic we cover in Value stocks: Why you might be underweight and unaware. Both scenarios suggest this may be an appropriate time for investors to assess their portfolios with an eye to restoring balance.

Final reflections to start a new year

The “Magnificent 7” stocks have dominated the performance of the S&P 500 over the past two years. It’s because of fundamentals, Mr. DeSpirito says. The earnings of these seven mega-cap companies have outgrown the rest of the market by a wide margin. That gap is closing, he observes, but the valuation gap is still wide. This mismatch, he believes, sets the stage for the market to broaden out:

“Compare the first half of 2024 to the second half and you see the first-half returns were dominated by the Mag 7. In the second half it was more equal, and I would expect that to continue going forward.”

More broadly, Mr. DeSpirito says, it’s easy to have a fear of missing out after two years of strong markets. “It’s always the riskiest investments that do the best” in these environments. His advice: Fight the impulse to chase. “Stay invested, but do so in a very sensible, prudent way.”

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