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The year ahead promises to be interesting for investors. In the U.S., a business-friendly administration, lower interest rates, and possible corporate tax cuts may support earnings growth. But, high valuations have many investors on edge. Let's explore what experts say about these competing dynamics and their impact on different areas of the stock market in 2025.

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S&P 500 in 2025: Modest returns expected

The S&P 500 ( ^GSPC ) should produce modest returns in 2025, with volatility along the way. Marta Norton, chief investment strategist at retirement plan provider Empower, expects large caps will benefit from improving macroeconomic conditions and the ongoing adoption of artificial intelligence.

Norton cites valuation as an "important countervailing force." Valuation in this context refers to stock prices relative to earnings and other business fundamentals. When valuations are high, investors are paying more for earnings — usually with the expectation of strong growth. If the growth disappoints, volatility can result.

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Small and mid-cap stocks may outperform in 2025

Small and mid-cap stocks may outperform the S&P 500 in 2025. The driving force will be the outsized benefits smaller companies should see from lower interest rates and possible corporate tax reductions.

According to David Rosenstrock, director at Wharton Wealth Planning, small and mid-caps are more likely to rely heavily on variable-rate debt, while larger companies favor fixed-rate facilities. Variable-rate borrowers benefit immediately from rate reductions because their obligations get repriced quickly. Existing fixed-rate debt does not adjust to lower interest rates until refinanced.

Tax cuts can favor small and mid-caps because most of their revenues are usually earned in the U.S. Rosenstrock explains, "Reducing the corporate tax rate may provide greater relief for these asset classes than for large caps, whose geographic revenue sources are more diversified."

Growth stocks may underperform in 2025

Growth stocks may underperform in 2025. Crit Thomas, global market strategist at Touchstone Investments, cites high valuations and slower earnings growth as factors to watch. "These stocks may need to pause and allow earnings to catch up with valuations," Thomas said.

Additionally, growth index investors should be wary of concentration risk. As Thomas points out, "The top five stocks in the Russell 1000 Growth Index comprise 45% of the market cap." When only a handful of stocks drive the group's performance, volatility can result.

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Value stocks poised to outperform in 2025

Value stocks are poised to outperform in 2025. Value stocks are characterized by slow and steady growth and low valuation ratios. Many pay dividends and generate strong and rising cash flows.

Value stocks have largely underperformed their growth-oriented counterparts for the past decade. The year 2022 was the exception. James Lebenthal, partner and chief equity strategist at wealth advisor Cerity Partners, expects value stocks will shine again in 2025. "Their earnings growth rates are set to accelerate while their share prices have languished for most of the last 10 years," Lebenthal said.

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