December 12, 2024

3 Reasons the Bull Market Will Continue in 2025

The market is getting a little frothy.

The S&P 500 is up 5.5% in the five weeks since election day, though that’s a historically normal bump following an election. The bull/bear ratio topped 3.9 last week – just shy of the 4.0 “danger zone” that often precedes pullbacks, though it’s not the first time it’s been this high in recent months. And Bitcoin, an asset that thrives in bull markets and typically tops right before a major pullback, just crossed the $100,000 threshold for the first time and has more than doubled in the last three months.

So, there are plenty of signs that we could be hurtling toward a pullback – perhaps a significant one – in the new year. But that doesn’t mean the bull market will end. Pullbacks, even market corrections (i.e., a dropoff of at least 10%), are healthy. Like the just-completed Black Friday shopping holiday, consumers and investors are more likely to buy when there’s a steep discount involved. Thus, a 5-10% pullback from current prices could be a good thing. I think such a pullback is quite possible, if not likely, in the next couple months.

But I still think 2025 will be a good year for stocks. Here are three reasons why.

1. The Bull Market Is Still Young. The current bull market has lasted nearly 26 months, having technically begun after the October 2022 market bottom. If that sounds like a long time, it isn’t. The average bull market lasts longer than twice that at roughly 61 months – more than five years. The average gain during a bull market is 180%. The gain in the current bull market is about 68%. So, historically speaking, we could still be in the first half of this bull market. No bull market dies of old age anyway. And this one isn’t even “old.”

2. Fed Rate Cuts Are Just Getting Started. After the fastest rate-hiking program in history, in which the federal funds rate ballooned from near zero to a range of 5.25-5.5%, the Fed has started slashing rates in earnest, trimming by 75 basis points to a 4.5-4.75% range, with another 25-basis point cut likely coming next week. It won’t end there – not even with inflation still above the Fed’s preferred 2% threshold (the November print, out yesterday, came in at 2.7%, in line with economist estimates). According to the CME Group’s trusty FedWatch Tool, the majority (58.2%) of economists expect the Fed to cut rates by another 75 to 100 basis points over the next 12 months. There’s a 25% chance they’ll cut by even more than that. As interest rates decline, so will mortgage rates, which were well above 7% for a 30-year loan this time a year ago and are now in the mid-6% range. Chances are, as the Fed continues to cut, mortgage rates will dip below 6% for the first time in more than two years, and a long-dormant housing market – which accounts for 15-18% of U.S. GDP – will be revived, at least to some degree.

3. A Record Amount of Cash Is Still Sitting on the Sidelines. As of the end of the second quarter, a record $6.55 trillion was sitting in money market funds, up from $5.92 trillion a year ago and $5.22 trillion at the end of 2022. Anytime there’s that kind of spike in cash, it eventually gets deployed into stocks. The last big runup in money market fund reserves peaked in the second quarter of 2020. Over the ensuing two quarters, more than $300 billion of it was poured into the stock market, as the short-lived but powerful post-Covid bull market of 2020 and 2021 took off.

Expect a similar inflow this time, now that the bull market has spread beyond the Magnificent Seven and a handful of other artificial intelligence-related stocks. In fact, it’s already happening: net inflows into ETFs globally hit a record $205 billion in November, with U.S. equity ETFs accounting for $149 billion of the total – blowing away the previous monthly record of $98.5 billion, set in December 2023. Now that the election is over, interest rates are coming down, and the U.S. economy remains healthy, investors are finally starting to come off the sidelines and are feeling confident enough to turn their cash into stock investments.

As always, there are plenty of potential hurdles that could derail the bull market in 2025. Geopolitical turmoil continues to spread to places like Syria and South Korea. The new administration’s plans to issue high tariffs on China, Canada and Mexico could send consumer prices in the wrong direction again. And there’s always the unknown, which is what the market fears most.

But barring some sort of catastrophic, black swan event like a global pandemic or a sudden recession, I think the bull market will continue in 2025. While I don’t expect a third consecutive year of 20% gains in the S&P 500 to materialize, I think a more muted return of 10% or more, with perhaps even better performance from the many sectors and asset classes that have lagged behind mega-cap tech and AI stocks these last two years. I expect that to include value stocks, which are only up 40% since the bull market began 26 months ago, but which have been more in lockstep with the market of late, up 10% since the August market bottom.

We’ve seen this outperformance in our Cabot Value Investor portfolio, which has had more big winners (including several stocks that we’ve “retired” after they reached our target prices) than at any point in the last three years. We hope to keep identifying undervalued gems in the year ahead, which I believe will be another good year for stocks – even if there are some growing pains along the way.

Note to new subscribers: You can find additional commentary on past earnings reports and other news on recommended companies in prior editions and weekly updates of the Cabot Value Investor on the Cabot website.

Send questions and comments to chris@cabotwealth.com.

Also, please join me and my colleague Brad Simmerman on our weekly investment podcast, Cabot Street Check. You can find it wherever you get your podcasts, or you can watch us on the Cabot Wealth Network YouTube channel.

This Week’s Portfolio Changes
None

Last Week’s Portfolio Changes
New Buy – The Cigna Group (CI), with a 420 price target

Upcoming Earnings Reports
None

Growth & Income Portfolio

Growth & Income Portfolio stocks are generally higher-quality, larger-cap companies that have fallen out of favor. They usually have some combination of attractive earnings growth and an above-average dividend yield. Risk levels tend to be relatively moderate, with reasonable debt levels and modest share valuations.

BYD Company Limited (BYDDY) has long been one of China’s top automakers. What really sent its sales into hyperdrive, however, was when it made the switch to all battery electric and hybrid plug-in vehicles in 2022. Revenues instantly tripled, going from $22.7 billion in 2020 (a record, despite the pandemic) to $63 billion in 2022. Last year, sales improved another 35%, to $85 billion. This year, it’s on track for $106.4 billion, or 25% growth, with another 20% growth expected in 2025. The EV maker has emerged as a legitimate rival to Tesla.

But there’s even greater upside. Right now, BYD does roughly 90% of its business in China, accounting for one-third of the country’s total sales of EVs and hybrids this year. The company is trying to change that, recently opening its full-assembly plant outside of China, with a new plant in Thailand starting deliveries. A plant in Uzbekistan puts together partially assembled vehicles. A plant in Brazil is expected to open early next year. And BYD has plans to open more new plants in Cambodia, Hungary, Indonesia, Pakistan and Turkey. Mexico and Vietnam are possible targets as well. Despite no plans to do business in America just yet, BYD is on the verge of becoming a global brand.

And while BYDDY stock has fared well, it hasn’t grown as fast as the company. At 16.1x earnings estimates, BYDDY currently trades at less than 20% of its five-year average forward P/E ratio (89.6). And its price-to-sales (1.09) ratio is about half the normal five-year ratio. As BYD continues to expand globally, look for its valuation to catch up with its industry-leading performance.

After a rocky start, BYDDY shares were back with a vengeance this week, up 5.5% on scant news. It’s possible Wall Street finally woke up to the Chinese EV maker’s stellar November numbers in which it sold a record 506,804 electric vehicles, up 67.9% from last November and nearly 10% more than the 462,890 EVs Tesla sold in the entire third quarter! It was the company’s best month of the year and it’s now on track to top its lofty 2024 sales goals.

BYD is becoming an equal to Tesla. But Wall Street has yet to treat it as such. Thus, we set a 90 price target on the stock, giving it 29% upside from here. Long term, that seems pretty conservative. BUY

The Cheesecake Factory Inc. (CAKE) is ubiquitous. With 345 North American locations, chances are you’ve eaten at one, indulged in their specialty high-calorie but oh-so-tasty cheesecakes and browsed through menus long enough to be a James Joyce novel. But despite being seemingly everywhere already and nearly a half-century old, the company is still growing.

Sales have improved every year since Covid (2020), reaching a record $3.44 billion last year. This year, revenues are on track for $3.57 billion. But the earnings growth is the real selling point. EPS more than doubled in 2023 (to $2.10 from 87 cents in 2022) and are estimated to swell to $3.31 in 2024, a 57.6% improvement, and to $3.69 next year.

It’s still expanding too, opening 17 new restaurants year to date. It expects to open a total of 22 new restaurants by year’s end. Those aren’t just Cheesecake Factories – the company also owns North Italia, a handmade pizza and pasta chain; Flower Child, a health food chain that caters to those with special diets (vegetarians, vegans, gluten-free, etc.); and Blanco, a Mexican chain owned by Fox Restaurant Concepts, which The Cheesecake Factory Corp. acquired in 2019.

Despite some recent strength in the stock, CAKE shares trade at just 13.9x 2025 EPS estimates and at 0.70x sales. The bottom-line valuation is well below the five-year average forward P/E ratio of 15.6; the price-to-sales ratio is in line with the five-year average.

With shares trading at roughly 20% below their 2017 and 2021 highs, there’s plenty of room to run.

CAKE shares were unmoved this week on no news. That comes on the heels of a 10% bump the previous two weeks, with the onset of the holiday shopping season perhaps acting as a tailwind.

The last bit of company-specific news came in late October when the company reported Q3 earnings, which were solid. Sales improved by 4.2% while diluted EPS expanded by 65%. Same-store sales increased 1.6%. Initially, the impressive quarter did little for the share price. Now it’s playing catch-up.

I’ve set a price target of 65, 28% higher than the current price. The 2.2% dividend yield adds to the appeal. BUY

Dick’s Sporting Goods (DKS) has been growing steadily for years.

From 2016 to 2023, the sporting goods chain’s revenues have improved 64%, from just under $8 billion to just under $13 billion. This year, the top line is on track to top $13 billion for the first time. It should top $13.5 billion next year.

Dick’s, in fact, has grown sales in each of the last seven years – including in 2020 and 2021, when most other retailers saw sales nosedive due to Covid restrictions. But Dick’s all-weather ability to keep growing no matter what’s happening in the world or the economy speaks to its versatility. Since Covid ended, however, Dick’s sales have entered another stratosphere. As youth sports returned in 2021, Dick’s revenues jumped from $9.58 billion to $12.29 billion. They’ve been rising steadily each year since and are expected to do so again this year.

But Dick’s isn’t purely a growth stock—it’s also undervalued. DKS shares currently trade at just 14.4x forward earnings estimates and at 1.3x sales. To be sure, it’s not the cheapest stock in our portfolio. But it is one of the fastest growing – and pays a solid dividend to boot.

There was no company-specific news for Dick’s this week, and yet shares continued to climb in the wake of the company’s late-November earnings report, up 3.5%. It was yet another solid quarter for the sporting apparel giant. Both sales and earnings topped estimates and, perhaps more importantly, the company raised full-year same-store sales guidance to a range of 3.6% to 4.2%, up from the previous range of 2.5% to 3.5%. Earnings per share improved 15% year over year, while sales ticked up only slightly. The company credited a robust back-to-school shopping season for its strength in the third quarter. Also, Dick’s is expanding its new House of Sport concept – 100,000-square-foot arenas that feature rock climbing walls and running tracks. It expects to open 15 new ones next year and is aiming for a range of 75 to 100 nationwide by 2027.

DKS shares are now up 9% since the earnings report. They have 14% upside to our 250 price target. BUY

Toll Brothers (TOL) – Historically, when the Fed cuts interest rates, homebuilder stocks are among the first to benefit. Indeed, in 2019 and early 2020 (before Covid hit), during which the Fed cut rates from 2.5% to 1.5%, homebuilder stocks were up 64%, more than double the 30% bump in the S&P 500. Now, with the Fed finally cutting rates for the first time in four and a half years, the homebuilders are undervalued, trading at 13x forward earnings. Toll Brothers is even cheaper, trading at 10.3x estimates – and growing faster than the average bear. In fiscal 2024, analysts anticipate 19% EPS growth on 7.5% revenue growth, both of which would easily top 2023 results (13.6% EPS growth on a 2.7% downturn in revenues).

Toll Brothers isn’t the biggest homebuilder in the U.S. – its $10 billion in revenue last year paled in comparison to the likes of D.R. Horton’s ($35 billion), PulteGroup’s ($16 billion), or Berkshire Hathaway holding Lennar’s ($34 billion). But it’s cheaper and growing faster than all of them.

Toll Brothers reported earnings on Monday that topped analyst estimates, but the stock has been punished anyway, to the tune of an 8% dropoff. There was nothing wrong with the numbers. In its fiscal fourth quarter, revenues came in at $3.33 billion, handily beating estimates of $3.17 billion and up 10% year over year. Adjusted earnings per share came in at $4.63, 7.7% higher than estimates and up 12.7% year over year. The company also increased its full-year guidance, forecasting new homes built between 10,650 and 10,750 homes for the year, with an average price of $975,000, a $10,000 increase from previous estimates.

For full-year 2024, the company reported $10.6 billion in revenue, a new record, and an 8.5% improvement over 2023.

So, why have shares sold off since the report? Several high-flying stocks have gotten dinged in the last couple days as sellers have come for stocks with “meat on the bone,” so it’s possible they spotted an opportunity in TOL, which was up 3.5% in the two weeks prior to the report. Also, the homebuilder did fall short of its margin forecast for the quarter, but that seems more like a nitpick than a cause for an 8% selloff. My guess is the stock will be back in the coming weeks as investors warm to its strong Q4 and full-year 2024 results.

TOL shares have 25% upside to our 180 price target. Coming off a very encouraging year and with interest rates coming down, I fully expect TOL shares to reach our price target in the coming year. BUY

United Airlines (UAL) – People are flying in planes again in Covid’s aftermath, and no major airline is taking advantage of it quite like United.

United Airlines is the fastest-growing major U.S. airline. The third-largest airline carrier in the world by revenues behind Delta (DAL) and American (AAL), United is expected to grow sales by 5.9% in 2024 – more than its two larger competitors – and that’s with revenues already topping a record $50 billion in 2023 – 19.6% higher than in 2022, which was also a record year. For United, business has not only returned to pre-pandemic levels; it’s better.

Meanwhile, the stock is super cheap. It trades at a scant 7.7x forward earnings estimates, with a price-to-sales ratio of just 0.57. The stock peaked at 96 a share in November 2018; it currently trades at 94.

A company that’s making more money than ever before (gross profits reached a record $15.2 billion last year, though earnings were still second to 2019 levels on a per-share basis), and yet its stock trades at barely more than half its peak from five and a half years ago. A true growth-at-value-prices opportunity.

UAL shares finally took a breather after weeks of nothing but runups. Considering there was no news and that the stock is already trading around all-time highs, this week’s pause feels more like a win.

Having blown past our 70 price target more than a month ago, we’ve already booked profit on half our position and are holding the remaining half until UAL encounters some real turbulence. In the heart of holiday travel season, I don’t expect that to happen until at least the new year. HOLD HALF

Buy Low Opportunities Portfolio

Buy Low Opportunities Portfolio stocks include a wide range of value opportunities. These stocks carry higher risk than our Growth & Income stocks yet also offer more potential upside. This group may include stocks across the quality and market cap spectrum, including those with relatively high levels of debt and a less clear earnings outlook. The stocks may not pay a dividend. In all cases, the shares will trade at meaningful discounts to our estimate of fair value.

ADT Inc. (ADT) is literally a household name.

It’s a 150-year-old home security company whose octagon-shaped blue signs with white lettering that say “Secured by ADT” are ever-present in neighborhoods across the country. ADT provides security to millions of American homes and businesses, with products ranging from security cameras, alarms and smoke & CO detectors, to door/window/glass break sensors and more, all of which can alert one of ADT’s industry-best six 24/7 monitoring centers if any one of those security systems is breached.

Business has been fairly stable, with annual revenues hovering in the $5 billion range for four of the last five years (2021 was an exception, with a dip down to $4.2 billion during Covid) and is on track to do it again both this year and next. But where the century-and-a-half-old company has really improved of late is profitability. The last two years marked the first time the company has been in the black in consecutive years, with earnings per share going from 15 cents in 2022 to 51 cents in 2023; this year, EPS is expected to improve another 43%, to 73 cents, and then to 83 cents (+14%) in 2025.

All of that EPS growth makes the share price look quite cheap. ADT shares currently trade at just under 10x earnings estimates and at just 1.33x sales. A solid dividend (3.1%) adds to the appeal of this mid-cap stock.

ADT shares were off about 3% on no news, falling below their recent 7.5 to 7.6 range to 7.3/7.4.

In late October, ADT reported earnings that beat on both the top and bottom lines, prompting a 7% boost in shares since. Adjusted EPS of 20 cents topped 17-cent estimates, while revenues ($1.24 billion) narrowly edged estimates ($1.22 billion), and marked a 5% year-over-year improvement. EBITDA ($659 million) also came in slightly higher than expectations. Meanwhile, the company maintained its full-year revenue guidance of $4.9 billion and raised EPS guidance to 73 cents at the midpoint – a 3.6% increase. Its recurring monthly revenue reached $359 million, a new record.

The numbers weren’t jaw-dropping, but there was a lot to like in the report, and investors quickly snatched up ADT shares accordingly – they were trading below 7 prior to the report. But the stock remains cheap, trading at 9.6x forward earnings. The shares have 35% upside to our 10 price target. BUY

Aviva, plc (AVVIY), based in London, is a major European company specializing in life insurance, savings and investment management products. Amanda Blanc, hired as CEO in July 2020, is revitalizing Aviva’s core U.K., Ireland and Canada operations following her divestiture of other global businesses. The company now has excess capital which it is returning to shareholders as likely hefty dividends following a sizeable share repurchase program. While activist investor Cevian Capital has closed out its previous 5.2% stake, highly regarded value investor Dodge & Cox now holds a 5.0% stake, providing a valuable imprimatur as well as ongoing pressure on the company to maintain shareholder-friendly actions.

It appears Aviva’s hostile takeover of U.K. motor insurance company Direct Line is going to work. After Direct Line rejected its initial takeover bid of 3.4 billion pounds, Aviva upped its price to 3.6 billion pounds, or $4.6 billion, which Direct Line has signed a preliminary agreement on. The acquisition would give Aviva the lion’s share of the U.K. motor insurance market, creating an entity with a combined market cap of $21.2 billion, up from its current $16.35 billion. That gives AVVIY shares 30% upside from their current price. Given this potential merger, our 14 price target is starting to look conservative, even though AVVIY shares were largely unchanged this week. BUY

The Cigna Group (CI) is the fifth-largest healthcare company in the U.S., with $229 billion in revenue over the last 12 months. It’s a health benefits and medical care provider with a market cap of $82 billion, 170 million customers in over 30 countries, that pays a dividend (1.8% yield) and is on track to grow sales by 25% and earnings by 13.5% this year and another 10.8% next year. And yet, the stock hasn’t budged much in two years and trades at less than 10x earnings estimates and 0.39x sales. It’s the cheapest CI shares have been in more than a year.

Why the underperformance? Earnings have been inconsistent, with EPS declining 18.8% last year and 31.4% in 2021. But that appears to be changing, with double-digit growth expected both this year and next, led by its Evernorth Health Services branch, which reported 36% revenue growth in the latest quarter. And healthcare stocks as a group have been the worst performer of the 11 major S&P 500 sectors in 2024, up a mere 5.7%. As Baby Boomers reach their golden years, healthcare is more in demand than ever, so the sector won’t stay down long. And CI has a habit of outperforming when times are good.

Cigna had a terrible first week in our portfolio. CI shares were down nearly 11%, though the company itself didn’t do anything wrong. The murder of UnitedHealth Group CEO Brian Thompson last week, combined with lawmakers coming for big pharma companies and possibly forcing them to sell off their pharmacies, has sent healthcare stocks as a group tumbling more than 3%. Why CI’s decline has been far more precipitous than that is unclear, though it’s roughly in line with UNH’s 12% dropoff, as big pharma companies especially are being targeted, for lack of a better term, right now.

But again, all these bad (and disturbing) headlines don’t change the fact that Cigna is growing both its top and bottom lines just fine, it’s cheap, and the aging of the population theme is not one that’s going suddenly reverse.

So, if you have not yet bought CI shares you can now get in at an even better entry point, with 42% upside to our 420 price target. BUY

Note for stock table: For stocks rated Sell, the current price is the sell date price.

Current price is yesterday’s mid-day price.

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