As we step into the new year of 2025, the dynamics of the stock market are beginning to display intriguing changes, notably marked by an increased level of divergence among individual stocksThis phenomenon has enabled a greater proportion of equities to outperform the renowned S&P 500 indexAfter experiencing a profound concentration of returns over the previous two years, this shift opens new doors for investors, particularly stock pickers aiming to surpass benchmark performance.

According to recent data released by the financial news service, by the close of last week, the S&P 500 index posted a modest year-to-date gain of 2.4%, with over 49% of its constituent stocks outperforming this benchmarkShould this trend persist through the first quarter, we might witness the broadest market participation since 2022. In stark contrast, during the years 2023 and 2024, fewer than 30% of S&P 500 components delivered returns that outpaced the index itselfThis was a time dominated by a few colossal tech giants, most notably Nvidia, which propelled the S&P 500 to annual gains surpassing 20% for two consecutive years, a phenomenon reminiscent of the late 1990s market rush.

This palpable shift in market behavior, coupled with rising expectations from options traders anticipating increased volatility in single-stock performances, could herald a new dawn for actively managed fundsFinancial experts have posited that the growing differentiation in stock performance is a positive signal for active management strategiesBen McMillan, Chief Investment Officer at IDX Advisors, has articulated that this heightened divergence presents a favorable landscape for active investment, suggesting the potential emergence of another "golden age" for such methodologies.

In tandem with these market observations, the Chicago Board Options Exchange (Cboe) has noted an uptick in its Stock Dispersion Index, which recently soared to a three-year highTypically, this index sees a decline during earnings season, yet it has shown an unexpected rise in recent weeks, indicating that individual stock performance may be diverging more profoundly than previously anticipated.

Several factors contribute to this remarkable shift in the markets:

Firstly, there is an observable enhancement in corporate earnings

Advertisements

Analysts speculate that by the fourth quarter of 2024, earnings growth will become more widespread, with expectations that it will not solely revolve around the performance of the so-called "Fantastic Seven." This gradual realization is diluting the concentrated nature of the market considerably.

Additionally, uncertainties surrounding market conditions and the economy are prompting investors to scrutinize the potential risks tied to the U.S. presidency's policy agenda and evaluate whether massive corporate investments in artificial intelligence infrastructure are indeed prudentialMoreover, the fundamental strength of the U.S. economy has come under scrutiny, leaving many investors contemplating the sustainability of returns in such an unpredictable environment.

Furthermore, the volatility observed in individual stocks is heavily influenced by factors such as developments in AI, fluctuating tariff policies, and broader macroeconomic outlooksMandy Xu, Head of Derivatives Market Intelligence at Cboe, underscored in a recent interview that the pronounced volatility remains prevalent, even post-earnings season, as these overarching themes significantly impact stock performances.

It’s essential to understand that over the past few years, actively managed funds have struggled to keep pace, particularly amidst an environment where market returns have been largely concentrated among a select few entitiesAccording to the S&P Dow Jones Indices, fund managers who neglected holdings in leading stocks among the "Fantastic Seven," such as Nvidia, or growth momentum stocks like Palantir and Vistra, were virtually guaranteed to underperform the S&P 500.

As we look towards the first half of 2024, challenges remain for active management funds, especially those invested in U.S. and global equitiesAnu Ganti, Head of U.SIndex Investment Strategy at S&P Dow Jones Indices, noted that the first half of 2024 may become recorded as another challenging period for the active management sector, given the prevailing conditions.

It is also worth noting a shift in market styles

Advertisements

The technology sector, which has often been viewed as overvalued, is experiencing a downturn, whereas more reasonably valued sectors such as consumer staples, financials, and healthcare have commenced 2025 with meaningful gainsThis reversal highlights how market sentiment can swiftly pivot based on prevailing economic indicators.

Among the "Fantastic Seven," the majority of companies have underperformed since the beginning of 2025, with Meta being a unique outlier, witnessing a substantial uptick in its stock priceConversely, the other members of this elite group have either faltered or remained relatively stagnantNevertheless, despite a reduction in market concentration, the top ten stocks within the S&P 500 (which still includes all "Fantastic Seven") account for over 37% of the total market capitalization of the indexThis figure, however, has seen a decline from its peak in 2024.

Chief Market Strategist Jeff Schulze from ClearBridge Investments has highlighted a historical trend showing that when the concentration of the S&P 500 exceeds 24%, the equal-weighted indices tend to outperform their market-cap-weighted counterparts in subsequent yearsThis principle has been validated 96% of the time since 1989, underscoring the potential for this current market divergence to favor broader investment strategies.

Despite the limited historical data, the prevailing conditions appear to align with this patternSince the start of 2025, the Invesco S&P 500 Equal Weight ETF has recorded gains approaching 3%, contrasting the S&P 500's growth of just 2.3%. Such figures rekindle interest in equally weighted strategies, suggesting that investors may be looking to diversify their portfolios away from exclusively large-cap stocks.

The global equities landscape is also witnessing robust growth as markets in Europe and China post double-digit increases in 2025, significantly outpacing the S&P 500. As a result, with actively managed funds consistently lagging behind benchmark indices, many investors have redirected their capital towards lower-cost index ETFs

Advertisements

Advertisements

Advertisements