The year is almost over, and it's time to make some bold predictions for 2025.
In this article, three Motley Fool contributors draw on their experience to forecast what may be in store for the stock market next year. Here's what they have to say about Artificial Intelligence (AI) software stocks, Ark Innovation ETF, the Magnificent Seven, and more!
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Prediction: AI software stocks will rock and roll in 2025
Jake Lerch (AI software stocks): My prediction is that 2025 will be the year of software stocks. Think about it: Hardware stocks were some of the top-performing stocks of 2024. Semiconductor companies like Nvidia, Broadcom, and ARM Holdings saw their stocks skyrocket as demand for high-powered chips went through the roof.
However, as the calendar turns from 2024 to 2025, I predict that the stock market may begin to shift its attention away from chip stocks and toward software stocks like SoundHound AI and Palantir.
Indeed, over the last few months, a shift has already started, with the stocks of application-makers like SoundHound and Palantir outpacing semiconductor stocks like Nvidia and AMD.
What's more, some of these software companies remain relatively small in terms of market cap. As of this writing, SoundHound AI sports a market cap of about $8 billion. That makes it a potential acquisition target for deep-pocketed tech mega-caps. For example, Meta Platforms has over $70 billion in cash on hand -- more than enough to snap up SoundHound with tens of billions in cash left over.
But it's not just the upstarts that could benefit from the shifting focus to software. Companies in the digital advertising and digital learning spaces could also benefit as stock market participants look beyond AI hardware to some of its practical applications. Reddit is testing an AI-powered answering tool that could help the company draw more users -- and ad dollars. Learning app Duolingo is expanding beyond language learning by incorporating music and math lessons. Those new lessons -- powered by AI -- will help Duolingo attract more users and subscribers.
In short, the everyday uses of AI are nearly limitless -- and they're just starting to roll out. Because of that, I predict 2025 will be the year that AI-powered software shines bright.
Prediction: The broadening of the tech rally will boost this ETF
Will Healy (Ark Innovation ETF): Although many investors profited from the latest bull market, the rally was not broad-based. Instead, most of the benefit went to the top stocks. One can see this when comparing the performance of the S&P 500 over the last two years to that of the Russell 2000.
This has worked against Cathie Wood's Ark Innovation ETF (ARKK -2.77%), as most of its holdings are not S&P 500 stocks. The ETF is up by just over 20% this year, and all of that gain occurred following the U.S. presidential election.
Fortunately for Ark Holdings, many of these stocks left behind by the current rally seemed to move off their lows in recent weeks. As interest rates fall and post-election optimism rises, this should bode well for Cathie Wood's flagship ETF.
To see this, one only has to look at its holdings. Of its top 10 positions, only Tesla (NASDAQ: TSLA) and Palantir (NASDAQ: PLTR) are S&P 500 stocks. However, the recovery is now trickling down to the non-S&P holdings.
For example, its second-largest holding, Roku (NASDAQ: ROKU), makes up more than 9% of the fund and appeared to miss most of the current tech rally. While Roku is still more than 80% lower than its 2021 high, its stock has risen by over 60% from its August low, an improvement helping the Ark Innovation ETF.
The improvement is more profound for fourth place holding Roblox (NYSE: RBLX), which is around 6% of the Ark Innovation ETF. Although that stock has stagnated since the 2022 bear market, it has doubled in value from its May low. The rally started even earlier for a stock that is 5% of the fund, Robinhood Markets (NASDAQ: HOOD), which is up over 240% this year!
Such improvements are indicators that the tech rally has finally moved beyond the Magnificent Seven and other top stocks. As we move into 2025 and the rest of the tech sector finally begins to rally, a long-awaited recovery for the Ark Innovation ETF appears to be at hand.
Prediction: Valuations in some of the popular mega-cap technology stocks will start turning over
Justin Pope (Magnificent Seven): Anyone with investment exposure to the Magnificent Seven stocks, including Apple, Alphabet, Amazon, Meta Platforms, Microsoft, Nvidia, and Tesla, has likely enjoyed the past two years. The Magnificent Seven represents approximately 32% of the S&P 500 index, so their widespread outperformance has helped carry the stock market.
My 2025 prediction is that some of these names will start running out of steam.
These companies lead or compete in a handful of high-growth end markets, including e-commerce, digital advertising, cloud computing, semiconductors, artificial intelligence (AI), robotics, and more. If you're investing for the long term, the Magnificent Seven should still be a winning choice.
However, some of these companies have risen so much that their valuations have gotten ahead of the underlying businesses, which could lead to a down year for some big names in 2025. For example, Apple's AI tech, Apple Intelligence, may not be the home run investors hoped for. Yet, the stock trades at 34 times earnings despite analysts forecasting under 10% annualized long-term growth. That's a pretty steep valuation.
Tesla has rallied hard since the presidential election but trades at 177 times its earnings despite soft sales in its core vehicle business. Analysts estimate Tesla will grow earnings by 8% annually over the next several years, which is nowhere near enough to justify such a high price-to-earnings (P/E) ratio.
Some Magnificent Seven names could keep running next year. Alphabet and Meta trade at P/E ratios of 24 and 27, respectively. Meanwhile, analysts believe they will each grow earnings by 16% to 18% annually over the long term. That's far more growth at a better price than you're getting from Apple and Tesla.
The bottom line? Investors should pay close attention to the growth they're getting and the price they pay for it. Indiscriminately buying the Magnificent Seven has worked for two years, but that trend may soon end.
