2025 Market Outlook: Key Risks and Opportunities
The outlook for 2025 is shaped by several crucial risks that could impact the ongoing bull market, which had been quite fruitful for investors until about a year ago. When you take a snapshot of the market, it appears quite promising.
The Invesco Nasdaq 100 ETF (QQQ) has surged in 2025, marking a significant comeback compared to its performance early in the century. The accompanying chart reflects impressive one-year returns, with the S&P 500 Index ($SPX) benefiting from QQQ’s nearly 30% increase over the past year, as well as record gains over three years.
Given the current environment, particularly the focus on AI stocks that are driving QQQ’s growth, there’s potential for QQQ to climb another 30%. Looking back to 2000, QQQ experienced both a 75% rise and a 75% drop within the same year. The atmosphere now feels somewhat similar, though the market’s current fixation on AI over other sectors raises questions.
If you analyze the broader S&P 500, it’s evident that while some stocks have fared well, many are lagging behind. So, what’s the issue? The high returns of the past seem to be fading. As the market progresses, it appears likely that we’ll witness two sequential trends:
- Though QQQ may continue to rise and exceed many expectations, other stocks are starting to reverse their trajectories.
- Moreover, the lead that QQQ once had may be diminishing, and the remaining stocks won’t be able to support it.
The Market’s Dependence on QQQ
AI trading is reminiscent of the transformative and lucrative dot-com era from 25 years ago. However, it’s doubtful that current expectations will be fully met. The stock market may indeed continue its ascent, but only for a limited time unless unexpected challenges arise.
A year ago, I had pointed out a growing concentration among the largest stocks. This trend deepened, with wealth accumulating among the top performers, while average stock prices within the S&P 500 have been declining swiftly. Small-cap stocks are also likely to face intense pressure next year, many confronted with looming “debt cliffs” that will necessitate borrowing to remain viable.
This situation is particularly evident among microcap stocks, which typically rise in a “risk-on” environment but have significantly underperformed QQQ by about 100% over the last three years. Quite surprising, right?
Today’s market resembles an athlete relying on a single strong leg. Sure, you can keep achieving for a while, but there’s always the risk of a rapid decline.
As for my trading strategy, it’s heavily centered on QQQ. Essentially, I consider QQQ to be the more profitable aspect of the S&P 500. That’s my foundation, hedged as always. My focus is on identifying opportunities within the broader US stock market, especially where it might decline.
Strategies for Small Stocks
This leads me to inverse ETFs like the Pro Shares Short Russell 2000 ETF (RWM), which I’ve turned to for years. When the small-cap market struggles, I find it wise to have a plan ready to spring into action.
A put option on the Russell 2000 iShares ETF (IWM) represents a similar directional strategy, though trading options comes with both benefits and drawbacks. They have a time limit, volatility can fluctuate, and initial costs can be high. Here’s a specific instance:
Currently, IWM is priced around $245. Until December 19th, you can purchase the right to sell 100 shares at $230, which is about 6% lower than recent trading values. That option costs around 1%, which seems reasonable given IWM’s “IV rank” is now at 15%, suggesting it’s near its historical low.
While AI trading remains robust, a downturn could shift the market dynamics in favor of those who can strategize defensively as well as offensively.
