2025 Outlook & Top Stock Pick

Markets

The S&P 500 has experienced remarkable growth in 2024, with a year-to-date (YTD) performance of 27.8%. This exceptional performance is largely attributed to the "Magnificent Seven" stocks - Amazon, Apple, Alphabet, Meta, Microsoft, Nvidia, and Tesla - which have collectively risen 42% YTD, compared to 18% for the other 493 stocks. These seven companies now account for nearly half of this year's S&P 500 returns, significantly above their historical average contribution of 20%.

Despite this concentration, the S&P 500's gains have been primarily driven by multiple expansion rather than earnings growth. The index's price-to-earnings (P/E) ratio has reached an all-time high of over 22x (excluding the COVID-19 period), while the MSCI ACWI global index is trading at 18.3x, also at record levels. These elevated valuations suggest limited room for further multiple expansion in 2025.

Looking ahead to 2025, earnings growth will likely be the key driver of stock returns. Current consensus estimates project mid to high single-digit earnings growth, while multiples are expected to contract by approximately 5%. This combination points to potential low single-digit stock returns for the coming year.

Following Trump's victory, financial markets have adopted an optimistic stance, primarily driven by expectations of deregulation and additional tax cuts that could boost future corporate profits. However, this optimistic outlook may not fully account for potential negative consequences such as increased inflation due to tariff policies, rising long-term interest rates, and a potential decline in global trade volumes. While investors are focusing on the potential benefits of Trump's pro-business agenda, they may be underestimating the risks associated with inflationary trade policies and their impact on the broader economic landscape.

Economy

In 2024, financial markets have been supported by a best case scenario macro backdrop/soft landing. The US economy avoided a recession, corporate profits have been expanding, we've seen inflation come closer to 2%, real GDP growth averaging 2% and unemployment remaining at around 4%. All these factors have led the central banks to pivot their policies and start cutting rates. 

In 2024, financial markets have been buoyed by a favorable macroeconomic backdrop characterized as a "soft landing." The U.S. economy has successfully avoided a recession, corporate profits have been expanding, inflation is approaching the target rate of 2%, real GDP growth is averaging around 2%, and unemployment remains stable at approximately 4%. These positive indicators have led central banks to pivot their policies and begin cutting interest rates. Economic growth in the U.S. has persisted despite quantitative tightening for several reasons. Households and corporations have utilized excess savings accumulated during the COVID-19 pandemic to sustain spending. Additionally, nominal demand has significantly outpaced supply, allowing real economic activity to catch up even years later. While there has been a reduction in cash balances for both individuals and corporations, many businesses have continued to invest in capital expenditures (capex) rather than scaling back spending, leveraging their cash reserves even amid declining profits.

What are the best/worst case scenarios for 2025?

Best case: rate cuts during periods of economic growth typically support equity markets. Policies reminiscent of those from the Trump administration could foster a corporate-friendly environment with robust growth and falling inflation. This could lead to a year characterized by disinflation and moderate economic expansion alongside easing monetary policy. 

Worst case: conversely, the worst-case scenario may involve a slowdown in U.S. economic growth due to the delayed effects of higher interest rates. Continued tightening could dampen nominal demand; this year’s lower nominal demand has already contributed to reduced inflation rather than lower growth because demand has consistently exceeded supply. This trend cannot persist indefinitely; eventually, lower nominal demand will likely lead to declines in real growth as well. Given that markets are currently pricing in moderate growth for next year, risks such as persistent inflation, elevated interest rates, and diminishing nominal demand could pose significant challenges heading into 2025.

Top stock pick into 2025? 

My top pick for 2025 is Taiwan Semiconductor Manufacturing Company (TSMC). 

Brief summary: TSMC is a leading contract manufacturer of advanced semiconductors and serves major clients such as Apple, Nvidia, and AMD. It is arguably one of the most important companies globally today; TSMC alone contributes nearly 20% of Taiwan's GDP. 

Industry: The semiconductor market historically operated on a vertically integrated model where companies managed design, manufacturing, and packaging internally. However, many skilled engineers in the 1980s aspired to start their semiconductor firms but lacked the capital required for manufacturing—today’s fabrication plants (fabs) cost around $40 billion each and are doubling in cost every four years according to Rock's Law. TSMC revolutionized this landscape by creating a foundry business model that allows "fabless" companies to design chips while outsourcing manufacturing to TSMC itself. This innovation facilitated the emergence of fabless companies like Nvidia, Broadcom, and Qualcomm that rely heavily on TSMC for production.

The foundry business requires significant scale and capital investment while being highly technology-intensive. A single misstep—such as Intel's failure to adopt extreme ultraviolet (EUV) lithography in 2015—can lead to long-term disadvantages within this competitive field. In the early 2000s, there were about 22 leading-edge foundries; today, only  three remain: TSMC, Intel, and Samsung. Today, Intel's CEO Pat Gelsinger announced his retirement from the company amid speculation that Intel may abandon its ambitions in leading-edge foundry services. This leaves TSMC as a principal player alongside Samsung; however, Samsung is also rumored to be undergoing a reorganization due to performance issues with its chips. Consequently, TSMC stands poised to solidify its leadership position within this critical industry—a situation further complicated by geopolitical tensions given its location in Taiwan and its significance to U.S.-China relations.

Revenue drivers: TSMC does not sell chips directly; instead, it sells wafers—thin discs that are subsequently cut into individual semiconductor chips. As technology advances toward leading-edge processes, TSMC not only increases its average selling prices (ASPs), which drive revenue growth but also produces larger chips that occupy more space on each wafer—resulting in increased wafer demand overall.

To go more into detail: if a 300mm wafer at a 5nm node costs $17k per wafer regardless of whether it contains ten or one hundred chips; every new node typically sees an increase in wafer prices due to additional manufacturing equipment requirements—such as moving from a 5nm node priced at $17k per wafer to a 3nm node priced at approximately $21.5k per wafer—a more than 25% increase relative to its predecessor node. Furthermore, volume considerations come into play: while it may be possible to fit sixty H100 chips on a single 5nm wafer, larger B100 chips can only fit thirty on that same wafer—meaning only half as many B100 volumes would be needed compared to H100s for breakeven.

Thesis: The investment thesis for TSMC hinges on its potential monopoly status as competitors like Intel and Samsung are forced to leave the race. Historical trends suggest that maintaining leadership in this sector is exceptionally challenging unless it is the sole focus of a company’s operations; AMD’s former CEO famously stated that “real men have fabs” until they faced difficulties and subsequently split their operations into GlobalFoundries (foundry) and AMD (fabless), allowing them to gain market share against Intel in both server and client CPU markets. The scale required for leading-edge manufacturing continues to escalate dramatically; Intel's focus on cost-cutting and being "thoughtful" on R&D does not coincide with the huge amounts of capex requires to survive at the leading edge. Intel has also cut capex twice in its latest 2 quarters. And government subsidies won't save the day; the US Chips Act allocates approximately $52B over five years across multiple companies. In contrast, TSMC invests about $40B annually in capex alone. As fabrication costs rise sharply over time, I expect that both Intel and Samsung will exit this competitive arena altogether while TSMC achieves a monopoly-like status.

Valuation: Trading at approx. 22x CY25 EPS, valuation is very undemanding for a company growing 20%+ CAGR with 40%+ EBIT margins with a huge value proposition, extremely solid moats/competitive advantage and a monopoly-like position.

Risks: As mentioned, there are risks with investing in TSMC. The first is, TSMC is also an enabler of AI for the US as it manufactures Nvidia's AI chips. This position places TSMC at the center of escalating tensions between the US and China regarding AI supremacy. The most severe risk is the potential for Chinese military action against Taiwan, which could be motivated by a desire to impede US progress in AI development. Such an event would have catastrophic consequences for TSMC. However, I would say that this is a systematic risk and not necessarily an idiosyncratic one, given TSMC manufactures ~65% of all semiconductors across the Mobile, Auto, PC, telco etc. space. If TSMC can't manufacture then Nvidia, Apple, AMD etc. will no longer be able to sell their products.