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2025 Market Outlook

Portfolio Durability and the Age of Alternatives

Key Observations

  • Full valuations, concentrated U.S. large-cap indexes and the risk of reigniting inflation are shaping the key themes we believe will drive markets and portfolio positioning in 2025.


  • Rising reinflation risk leads us to increase our allocation to more flexible fixed income strategies (dynamic bonds) while maintaining a core investment grade bond allocation.
  • Moving beyond passive toward active management and alternatives may offer a compelling opportunity to enhance portfolio resilience and adapt to the shifting landscape.

 

Portfolio Durability and the Age of Alternatives

As we officially close out 2024, we reflect on all that the year had to offer from sticky inflation to global elections and the dynamic and unpredictable nature of the financial markets. While inflation retreated from its 2022 highs, it remained persistent throughout the year. The Federal Reserve ultimately began to cut interest rates in September, which brought fixed income yields broadly lower from 2023. Despite a landscape marked by continued volatility, unexpected geopolitical events and a presidential election, the economy remained resilient and markets generally performed quite well.

As we begin 2025, we highlight the fragility within U.S. equities, driven by the narrow leadership of the "Magnificent 7" and the potential for opportunity in areas beyond U.S. large-cap equities. This narrative only intensified and by the end of the year, the top 10 stocks of the S&P 500 accounted for over 38% of the index, up from 31% at the start of the year1. Still, opportunities remain. Small and mid-cap domestic stocks present an opportunity with less concentration and relative valuation compared to large-caps2. As we step into 2025, it is imperative our portfolios remain resilient and adaptable in order to navigate any volatility that may lie ahead.

2025 Themes

Markets stand at a crossroads. While opportunities and optimism remain, the path forward for portfolio allocations are anything but straightforward. This year, our outlook centers on three pivotal themes: fragility, durability and the age of alpha. Fragility captures the vulnerabilities embedded in global markets derived from full valuations, concentration and inflationary pressures. It is a call for caution and strategic foresight to mitigate risks. Durability highlights the need to build resilience through thoughtfully diversified asset allocations designed to withstand today’s risks and position portfolios for long-term success. Finally, The Age of Alpha emphasizes the importance of active management and alternative investments to drive positive outcomes in a market where traditional beta opportunities are scarce. Together, we believe these themes provide a framework for addressing uncertainty while identifying opportunities to enhance portfolio resilience and performance.

Fragility

Elevated valuations, intensified market concentration and the risk of a second wave of inflation sow the seeds of vulnerability in markets today. Both equity and fixed income valuations hover at precariously high levels. U.S. equity markets have surged in 2024, with the S&P 500 Index gaining 23.3% for the year following a 24.2% increase in 20233. Valuations for the index, as measured by price-to-earnings ratio, sit at 21.5x, close to the 20-year high and more than one standard deviation above the long-term average4. When compared globally, U.S. large-cap equities appear even more stretched relative to their non-U.S. counterparts, adding a layer of risk for investors overly concentrated in this space. Meanwhile, in the bond market, credit spreads (one valuation measure for fixed income) have compressed close to levels last seen before the ’07-’09 financial crisis.

Fueling a portion of these valuations has been the continued strength of large-cap companies concentrated at the top of the market. This narrow market leadership means that the fortunes of a handful of companies disproportionately influence the broader market. Any misstep—be it a disappointing earnings report or adverse development—could lead to significant volatility.

Further adding to the complexity is the potential threat of reinflation. While inflation has eased in recent years (U.S. CPI now sits at 2.7%5), it has not vanished, and there are potential rising inflationary pressures. Should reinflation materialize, it could upend expectations for financial markets.

Portfolio Impact

High valuations in both equity and fixed income markets, coupled with market concentration and the growing risk of reinflation, have created a fragile market environment. As we look ahead, navigating this landscape requires a disciplined approach, so consider strategies that balance opportunity with durability. Diversification, reevaluation of risk tolerances, careful selection of asset managers and a keen eye on market developments will be essential in navigating 2025.

 

Durability 

Investing is synonymous with taking risks and there are few, if any, investments that generate sufficient returns without it. While the risks we outlined above are not new to investing, they are particularly pronounced in today’s market. We believe this makes portfolio durability more critical than ever. The good news? Building a durable portfolio comes at a surprisingly modest cost for long-term investors. Furthermore, incorporating global equity allocations may enhance durability by mitigating the acute concentration risks often seen in U.S.-centric portfolios. Concentration amplifies outcomes—both wins and losses. A striking example is the return gap between the S&P 500 and its equal-weighted counterpart: over the past five years, the more concentrated S&P 500 has outperformed by over 3% annually6. While recent history demonstrates the upside of concentration (as seen by the “Magnificent 7”) the downside risks are just as real. Investors have numerous options to mitigate this risk and increase durability.

Portfolio Impact

Reduce reliance on concentrated indices. This can mean diversifying into other equity asset classes or incorporating fixed income. Another approach is allocating to less concentrated areas like domestic small and mid-cap equities or developed international markets. These indices typically feature less dominance by their top holdings, broader sector representation (including industries beyond technology) and greater geographic diversity. Simply put, at this point in the cycle, a globally diversified portfolio is likely to be more resilient than a narrowly focused one.

Our 2025 allocations will slightly reduce our overweight to U.S. large-cap equity in favor of U.S. small and mid-cap equity, while maintaining our international exposure as we await policy changes under the new administration in Washington.

 

The Age of Alpha

We believe three factors have converged making active management and alternatives more compelling today:

Valuations: With U.S. markets trading at elevated valuations, we believe this presents a relatively low hurdle for alternative investments to outperform while potentially reducing exposure to full market risk.

Concentration: A heavy reliance on a handful of stocks increases the overall risk for broader markets to sustain recent performance.

Volatility: Higher market concentration typically results in increased volatility which can impact on asset allocation. This dynamic creates fertile ground for stock selection and targeted opportunities for active management.

Portfolio Allocations

Final Thoughts

Full valuations, index concentration and the potential for a resurgence of inflation have set the stage for a fragile market environment. Can equity markets rise further from here? Absolutely. Yet the possibility of setbacks is equally real, underscoring the importance of durability as we head into 2025.

Reaffirming portfolio positioning and risk exposure is a prudent annual exercise, particularly in light of U.S. large-cap gains in the past 2 years. While timing markets is inherently fraught, the relatively modest long-term trade-off between equity, fixed income and alternatives forecasts opens the door to thoughtful conversations about portfolio construction.

Mitigating acute risks, such as concentration and inflation, calls for thoughtful diversification—leveraging global equity allocations, tailored fixed income strategies and a broader spectrum of private investments. Moving beyond passive and traditional approaches into active management and alternatives has the potential to enhance portfolio resilience.

We recognize that some of these adjustments may not align with the comfort of chasing what has performed best recently. As we look to the year ahead, our commitment remains steadfast: to make disciplined investment decisions that ensure our client portfolios are built to withstand future volatility with the goal of achieving long-term success.

Sources

1FactSet, Standard and Poor’s. J.P. Morgan Asset Management. As of December 31, 2024

2Morningstar. As of December 31, 2024. Small-cap = Russell 2000 Index, Large-cap = S&P 500 Index

3Morningstar. Year to date 2024 performance through December 31, 2024.

4FactSet. J.P. Morgan Asset Management. As of December 31, 2024. Based on forward 12-month price-to-earnings.

5FactSet. U.S. Bureau of Labor Statistics. As of December 31, 2024.

6Morningstar. As of October 31, 2024.

Disclosures

The information provided is illustrative and for educational and informational purposes only and does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor's particular investment objectives, strategies, tax status or investment horizon. You should consult your attorney or tax advisor.

The views expressed in this commentary are subject to change based on market and other conditions. This document may contain certain statements that may be deemed forward looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur. Certain targets within the presentation are estimates based on certain assumptions and analysis made by the advisor. There is no guarantee that the estimates will be achieved.

All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such.

No investment strategy or risk management technique can guarantee returns or eliminate risk in any market environment. All investments include a risk of loss that clients should be prepared to bear. The principal risks of Clarendon Private’s strategies are disclosed in the publicly available Form ADV Part 2A.

Diversification does not ensure a profit or guarantee against loss. Asset Allocation may be used in an effort to manage risk and enhance returns. It does not, however, guarantee a profit or protect against loss. Investments in mid-sized companies may involve greater risks than those of larger, better-known companies, but they may be less volatile than investments in smaller companies. Investments in small-sized companies may involve greater risks than in those of larger, better known companies. Index returns are unmanaged and do not reflect the deduction of any fees or expenses. Index returns reflect all items of income, gain and loss and the reinvestment of dividends and other income. You cannot invest directly in an Index.

Clarendon Private, LLC (“Clarendon Private”) is a registered investment advisor. Advisory services are only offered to clients or prospective clients where Clarendon Private and its representatives are properly licensed or exempt from licensure. For additional information, please visit our website at https://www.clarendonprivate.com/ or the Investment Adviser Public Disclosure website at www.adviserinfo.sec.gov by searching with Clarendon’s CRD # 316616