Earnings growth can help stave off stock market valuation concerns in 2025, ETF firms say

Market strategists at major ETF firms are optimistic about the stock market rally continuing in 2025, expecting large tech stocks to keep generating solid earnings and stave off valuation concerns in the near term. “We anticipate that US Large Cap equity can maintain its structural advantage over developed markets (DM) equities. US companies continue to deliver on what the market values most — profitability and earnings growth, driven mainly by the technology sector and the so-called Magnificent 7, in particular,” the State Street Global Advisors team said in an outlook piece. The ETF industry has seen a boom of new products in 2024, with new crypto funds raking in tens of billions of dollars, and leveraged single-stock funds seeing heavy trading volume. Still, the two most popular ETFs among investors in 2024 have been broad stock funds — the Vanguard S & P 500 ETF (VOO) and the iShares Core S & P 500 ETF (IVV) . The two ETFs have brought in roughly $160 billion of inflows combined and have total returns of 29% year to date, according to FactSet. The buying of those broad stock funds comes despite concerns among Wall Street strategists and professional investors about market valuations, and the heavy weight of a handful of tech stocks in the indexes. Valuations could hurt long-term performance, but not necessarily 2025’s numbers, according to Vanguard. “Over the short term, our analysis suggests that if economic growth and earnings hold up, U.S. equities could sustain elevated valuations. However, as the horizon extends, growth and earnings impacts diminish, with valuations eventually dominating returns as a ‘fundamental gravity,'” the Vanguard outlook said. If earnings don’t hold up, the gravity could have a faster impact. “Any misstep in earnings, particularly from the top names, would be cause for concern,” State Street said. Fixed income A key theme of the ETF industry in 2025 will likely be alternative strategies aimed at helping investors water down some of that valuation risk. That could include new funds with exposure to less liquid assets, like private credit . Of course, investors looking for alternatives to stocks don’t have to go too far in the weeds. Vanguard’s strategy team is bullish on fixed income broadly heading into the new year, due in part to diminishing expectations of Federal Reserve rate cuts. “Higher starting yields have greatly improved the risk-return tradeoff in fixed income. Bonds are still back. Over the next decade, we expect 4.3%–5.3% annualized returns for both U.S. and global ex-U.S. currency-hedged bonds,” the Vanguard outlook said. Broad bond funds were the most popular with investors in 2024, but some more targeted funds did break through. For example, the Janus Henderson AAA CLO ETF (JAAA) , focused on structured credit, has brought in more than $10 billion so far this year, according to FactSet. Higher yields may make equity market valuations even tougher to stomach, but that’s not a near-term concern, according to Kevin Khang, senior international economist at Vanguard. “As long as the economy’s sort of holding steady, generally speaking … then we anticipate that that’s going to mean that generally risk assets are not going to be too affected by a little bit of yield movements here and there,” Khang told CNBC. The BlackRock Investment Institute is less bullish on bonds than Vanguard, though it did highlight some opportunities in European credit . An active approach The 2025 global outlook from the BlackRock Investment Institute was overweight U.S. equities, though the firm is putting extra emphasis on active strategies and dynamic funds. The risk for investors is that these type of funds typically cost more than basic index products — generating more revenue for the issuer — and most active managers usually underperform the market in a given year. The upside is that a smart manager, or even a well-tuned rules-based fund, may be able to jump on hot stocks or trends earlier than passive funds. The iShares U.S. Equity Factor Rotation Active ETF (DYNF) , for example, has outperformed the S & P 500 in 2024. DYNF YTD mountain This factor rotation ETF has outperformed the S & P 500 in 2024. “I think it’s a really exciting time to be an active equity investor,” Tony DeSpirito, BlackRock’s global CIO of fundamental equities, said earlier this month. Investors looking to take a more active approach may also want to bet on certain sectors or industries. Jay Jacobs, the U.S. head of thematic and active ETFs at BlackRock, highlighted the iShares Health Innovation Active ETF (BMED) and the iShares U.S. Manufacturing ETF (MADE) in his outlook piece. The health-care fund could benefit from lower interest rates and the impact of artificial intelligence on drug development, while the manufacturing fund could be a political winner heading into 2024, Jacobs said. “While the future of these Biden-era policies may be uncertain under the new Administration, we believe additional policies could emerge following the 2024 elections to further accelerate the reshoring theme,” he wrote.