Investing.com -- Raymond James analysts predict a "reversion to the mean" trade in 1Q25, saying that extreme narrowing in U.S. equity markets during 4Q24 gives way to broader participation.
The report highlights parallels to investor behavior in the late 1990s and suggests that technical factors, rather than economic fundamentals, have driven recent trends.
The narrow market rally, initially concentrated on the "Mag 7" stocks, has spread to other sectors, leaving indices historically expensive in price-to-earnings terms, while the median equity remains relatively undervalued, according to the firm.
"For a lot of reasons, we suspect a 're-broadening’ of the U.S. equity market through a 'reversion' trade will occur in 1Q25," the firm wrote.
Key factors expected to drive this shift include a stabilization or decline in 10-year Treasury yields, which have been a significant influence on market breadth.
Raymond (NS:RYMD) James analysts pointed out that yield declines in July/August and post-election periods led to substantial broadening in equity markets.
Additionally, they believe that potential events like another debt ceiling debate or discussions about ending quantitative tightening could also pressure yields lower.
Historical data is said to support this outlook.
"The market has only narrowed this extreme and this fast (6%+ outperformance of large vs. mid/small in less than a month) less than 1% of the trading days in the past 20 year," Raymond James stated, adding that small and mid-cap stocks typically catch up to large caps during such reversals.
Drawing comparisons to the Trump trade of late 2016, the firm notes that significant sector and index reversion occurred in early 2017, with winners of the prior quarter becoming laggards and vice versa. Analysts expect similar upheaval in 1Q25.