Market dynamics in 2025

The Fed holds rates steady as Deepseek rattles the US Tech sector

Yesterday, The Fed held rates at 4.25-4.50%, with Fed Chair Jerome Powell stating, “Inflation has eased significantly over the past two years but remains somewhat elevated relative to our 2% longer-run goal.” Markets closed slightly lower yesterday with a 0.50% drop in the S&P 500.

Nividia closed down 4% at $123.70, down 13% since last week on the news of Deepseek’s arrival on the AI scene. Deepseek boasts seemingly superior performance and, most surprisingly, was developed at a fraction of the cost of leading LLMs. Interestingly, Nividia is still more than double its 52-week low (over 100% YOY gain) even factoring in the Deepseek news. Overall, tech stocks have regained some of the Deepseek dip, with the NASQAQ-100 Technology Sector Index (NDXT) down less than 2% since last week, remaining up 1.6% month-over-month.

What do value investors need to consider in 2025?

We previously discussed how the fundamentals of value investing remain the same over time. That’s true! But what is different today versus say 20, 40, or 60 years ago?

There have been several systemic shifts over time that are important to consider when investing in today’s markets. Today, we’ll cover them at a high level and then do a deep dive later into each factor: 1) Passivity, 2) Market Concentration, 3) Disruption, and 4) Valuation.

1) Passivity: Passive investing eclipsed active investing for the first time in 2023. Common knowledge for decades has extolled the virtues of indexing. The great Warren Buffet even endorsed index investing as the best strategy for the “know nothing” investor in a Berkshire Hathaway letter to shareholders back in 1993. However, with more investment dollars flowing into these funds now more than ever, a question arises: how does the index investor judge valuation? The fact is they do not. The index investor relies on the active investors to determine when to take profits and sell securities. The index investor is pouring 401K contributions into a richly valued market without considering the underlying VALUE of the future cashflows that they now own. In the 1990s and 2000s, indexing investing was an elegant “set it and forget it” approach, but that could prove disastrous going forward if there’s another “lost decade” type of situation (i.e., 2000 to 2014) where the market cratered for nearly 15 years.

2) Market concentration is at an all-time high. The “Magnificent 7” or M7 stocks — Apple, Microsoft, Nvidia, Alphabet, Meta, Amazon, and Tesla — represent approximately 35% of the S&P 500 index in market capitalization. Many investors in recent years have seen extraordinary gains by holding these stocks or the market overall, of which these seven stocks have been a disproportionate driver of the increase in value. But among all the optimism, I am reminded of an analysis Graham discussed in The Intelligent Investor about the so-called “Nifty Fifty.” Like the M7 today, the “Nifty Fifty” was the largest fifty companies in the 1960s that had strong economic moats — think General Electric, IBM, and Sears Roebuck & CO. Otherwise known as “blue chip” stocks, the Nifty Fifty companies were thought of as stocks you could buy and hold forever. However, Graham pointed out that the most attractive stocks of the day do not necessarily hold up over the long run:

3) Technological Disruption has never been more impactful for investors both as an opportunity and as a threat. The average lifespan of an S&P 500 company has declined dramatically with each new wave of deregulation and technological advancement. Today, with IoT, cloud computing, blockchain, AI, and quantum computing on the horizon, no business model is safe, and entire industries can be upended and reshaped. If you are buying an index fund you are buying into a basket of companies that could become disrupted: think of the Fortune 500 in 2001 with names like Toys R Us, Borders, and Kmart. Will banks like Bank of America and Capital One Financial be able to maintain their economic moats as more users embrace decentralized finance (DeFi)? How can TJ Maxx and Best Buy compete with Amazon and other online retailers in the long run with their lower cost structures? When investing in stocks in the modern era, understanding how a company makes money currently and in the future is essential, but just as important is understanding the potential for new entrants to develop a disruptive model that erodes the value of the incumbent over time.

4) Valuations are rich, but so is the money supply — throughout time, a rational person would expect reversion to the mean, i.e., if stock prices are too high, eventually they should come back down to reasonable levels. But what is reasonable in a world where the money supply is nearly 2x what it was in 2015 (10 years ago), 6x what it was in 1995 (30 years ago), and 50x what it was in 1965 (80 years ago)? Is a Schiller PE ratio mean of 20 the new normal (vs. the 15 historical average)? Is there now so much cash floating around that the return on investment (ROI) figures for any given investment will be lower across the board? Graham recommended a PE ratio of 15 as the upper bound for what constitutes a good stock candidate; given the sharp increase in the money supply in recent years, 20 might be the new normal for defensive stocks and 25 for stocks with more growth potential.

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CSX

CSX is a rail-based freight transportation company operating in the eastern United States with a market cap of $65B. Although incorporated in 1980, the company comprises many large historical rail networks you might remember from the game Monopoly, such as the Pennsylvania Railroad, the B&O Railroad, and the Reading Railroad.

CSX is a solid “defensive” stock, with a more predictable and perhaps less disruption-prone business model than other companies. It trades at a PE ratio of 18.3 (vs. the overall S&P 500’s 38.2) generating a dividend yield of 1.47%. In 2024, although revenue was down 1% and EPS was essentially flat, total volume growth increased 2% and intermodal volume increased 4%. Additionally, the company is seeing progress in initiatives around safety and efficiency improvement (e.g., horsepower per trailing ton, fuel efficiency). Further, Net Promoter Scores (NPS) hit an all time high and CSX maintains a strong balance sheet with current ratios remaining above 1.0 for eight years running.

Last week, CSX had its FY 2024 earnings call and things were not all that rosy, the stock has declined ~12% since November 2024, impacted by lower prices and volumes in coal, hurricanes that impacted the Southeast U.S., and the Francis Scott Key Bridge collapse in Baltimore which affected the ability to deliver to customers. The guidance for 2025 was a similar “mixed bag” with CEO Joe Hinrichs highlighting the following points:

• Volume growth expected to be in the low to mid-single digits

• FY revenue will be impacted by lower coal benchmarks, diesel prices, and volume mix, particularly in H1

• A continued emphasis on efficiency initiatives

• Flat CAPEX excluding hurricane rebuild spending

• Balanced and opportunistic approach to capital returns

In summary, we do not expect 2025 to be a breakout year for CSX in terms of share price appreciation. However, this is one to watch in Q2 and Q3 as the company pulls out of its “trough” in H1 2025. This is a company that, despite the headwinds of the hurricane and FSK Bridge collapse, is growing and well-liked by customers. CSX has grown 364% in the past 10 years and 28% in the past five years. It has a wide economic moat and a strong commitment to shareholder returns, with $882M in dividends and $3,482M in share buybacks in FY 2023, and $930M in dividends and $2,237M in share buybacks in FY 2024. As a long-term play, this company’s share price is currently beaten down and could be a nice addition in the months ahead.

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_{Legal Disclaimer: The Evolved Investor is for information purposes only and is, by law, not personal investment advice. Concepts and ideas are for your consideration only. We encourage our readers to do their own due diligence. Investing has inherent risk, and investments can lose value.}