Research in Focus: Quarterly Sector Update

Investors are entering 2025 in a generally upbeat mood, encouraged by a resilient U.S. economy, interest rate cuts, and stimulus in China. These factors have helped to extend the economic cycle, a fact that large-cap equity markets have been quick to price in. As such, we believe valuations are now vulnerable to potential downside risks, including the threat of higher long-term rates, geopolitical uncertainty, and policy shifts under the new U.S. administration. Meanwhile, major economies outside the U.S. have struggled to find their footing.

We are monitoring pockets of weakness in some countries and sub-sectors, and we are mindful of the lagged impact of higher interest rates on consumer credit. Specifically, here’s what our Research Sector Team Leads are excited – and concerned – about for the months ahead:

Communication Services | Josh Cummings

Artificial intelligence and digital disruption remain key drivers of opportunity in communication services.

The communication services sector was a good place to invest in the fourth quarter of 2024, driven by investor excitement over digital streaming, digital advertising, and artificial intelligence (AI). Despite near-term uncertainty around the pace of AI-related spending, we remain bullish on data center capital investment even as we foresee inevitable bumps in the road. We are also enthusiastic about other trends favoring communication services stocks. Digital advertising demand has remained solid for the largest online platforms, including Google and Meta, companies that also benefited from a surge in political advertising in the fourth quarter of 2024. Travel-related demand also remains strong and may even accelerate in early 2025. We are also keeping a close watch on the media industry given Comcast’s plans to spin off its linear cable networks, something we expect to create volatility but little economic value. We remain bearish on incumbent broadcasters and cable networks.

Consumer | Josh Cummings

Consumers spending trends remain resilient, but we see the potential for surprises.

The consumer has remained a strong engine of economic growth, with a robust jobs market, moderating inflation, and recent Federal Reserve rate cuts underpinning strength in retail sales and discretionary spending. As a result, we saw the rally in consumer discretionary stocks that started in August continue broadly through year-end 2024, with investors rotating away from defensive consumer staples stocks. We believe these trends could continue into 2025 even as we remain alert for surprises, especially given lofty valuations for some consumer discretionary companies and potential policy changes under the Trump administration. We believe a mix of cyclical and defensive businesses in the sector is appropriate, as we seek to avoid implied macroeconomic bets in favor of a focus on high-quality, resilient business models. Companies we believe are on the right side of digital disruption continue to be of interest, given the theme has permeated the consumer sector for the past 20 years and shows no sign of abating.

Energy & Utilities | Noah Barrett

We anticipate balanced market fundamentals for energy stocks in 2025.

We anticipate crude oil prices will oscillate between $70 and $80 per barrel, a narrow range that we expect will be maintained by relatively disciplined supply management by the Organization of the Petroleum Exporting Countries (OPEC). We also believe any increases in annual demand will be offset by incremental supply from non-OPEC countries, such as the U.S. Of course, oil prices often surprise the market, and we believe any breakout from this narrow band for a sustained period is more likely to be downward. This would especially be the case if OPEC, along with non-OPEC countries (OPEC+), relaxes supply constraints and allows more oil onto the market. We are also monitoring other developments such as potential tariffs and sanctions imposed by the Trump administration that could impact energy pricing and stock performance. Domestically, we see rising power demand as a key theme for both utilities and energy companies. We anticipate favorable pricing dynamics in the medium term, given tight supply/demand conditions, growing demand for power to support trends such as AI, and the inevitable lags in the creation of new capacity.

Financials | John Jordan

Cyclical and secular trends support investment opportunities in global financial services.

The global financial services sector, in our view, provides a rich landscape in which to deploy deep fundamental research. For example, we have identified a number of European banks that appear positioned to return significant capital to investors going forward, aided by a backdrop of non-zero interest rates and relatively stable and predictable regulation. While the market has begun to reward such stocks, we believe they still trade at attractive valuations.

Favorable cyclical trends exist in other areas of global financial services, especially around pricing in commercial property and casualty insurance, as well as in U.S. personal auto insurance. We are excited about secular trends such as the growth in electronic payments. We also see opportunity for companies that benefit from proprietary data and advanced technological capabilities or are starting to leverage AI to better serve customers, capture market share, or improve risk underwriting. Lastly, the expansion of insurance and banking services in markets where the penetration of financial products has been low now appears positioned for a long runway of growth.

Healthcare | Andy Acker

Innovation continues to drive investment opportunities in healthcare.

Following several years of relative underperformance, we see a healthcare sector characterized by accelerating innovation and discounted valuations. We are excited about new developments such as GLP-1 weight-loss drugs, which are already generating over $50 billion in annual sales, and robotic surgery and atrial fibrillation devices that tap large addressable markets. Industry pipelines also remain at record levels, with important late-stage clinical trial readouts expected in 2025. At the same time, we recognize sources of uncertainty, including possible healthcare policy changes under the Trump administration. It remains to be seen what changes will be implemented and whether other potential Trump policies, such as lower taxes and a more accommodative Federal Trade Commission, could benefit healthcare stocks. Moreover, we believe any downside risk is more than reflected in today’s discounted valuations, and that investors could come to appreciate the sector’s defensive qualities should the broader market — now in our view priced for perfection— hit a speedbump. In seeking opportunities, our focus remains on pharmaceutical and medical device companies with improving growth potential. We are also looking to small- and mid-cap biotech companies with new products or promising late-stage pipelines, as well as leading health insurers working to improve value in the healthcare system while delivering expanding profit margins.

Industrials | David Chung

Monitoring whether the U.S. election revives animal spirits in industrials.

The industrials environment has been stuck in neutral for a while, with cyclical end markets such as freight, factory automation, and off-road machinery continuing to face headwinds. It remains to be seen whether the U.S. election – the leadup to which caused customers to pause orders – can resurrect business confidence and capital expenditures in the industrial economy. If so, we could see a positive inflection for industrials stocks with short-cycle businesses – something to watch. One notable exception has been the creation of the Department of Government Efficiency, which is tasked with improving the federal government’s productivity. Government services firms sold off on worries about the impact on demand for these companies, but we believe the reality will be more muted, potentially creating an opportunity to add to these stocks at attractive valuations. Meanwhile, areas of secular growth, such as commercial aerospace and electrification, continue to show robust strength.

Information Technology | Denny Fish & Jonathan Cofsky

AI remains a strong driver of investment opportunities across information technology.

We are bullish on the outlook for information technology stocks in 2025. As more companies deploy AI to boost productivity, and households increasingly rely on AI to accomplish daily tasks, we believe the most innovative and forward-looking companies will increase their shares of aggregate global earnings. We expect a relatively narrow group of winners to emerge among companies creating the necessary infrastructure to support AI. These include producers of the graphic processing units critical to AI, the factories that build these components, and makers of the capital equipment required for such engineering feats. Software companies capitalizing on AI-driven efficiencies are also likely to benefit, as are internet companies aggressively seeking to leverage AI to improve competitive positioning in verticals such as travel, e-commerce, food delivery, and music. There are, however, some risks for 2025, including on the regulatory front. We expect certain export controls to remain in place or become more restrictive under the new administration. And in the internet space, leading companies will likely continue to face questions about their size and reach.

IMPORTANT INFORMATION

Health care industries are subject to government regulation and reimbursement rates, as well as government approval of products and services, which could have a significant effect on price and availability, and can be significantly affected by rapid obsolescence and patent expirations.

Technology industries can be significantly affected by obsolescence of existing technology, short product cycles, falling prices and profits, competition from new market entrants, and general economic conditions. A concentrated investment in a single industry could be more volatile than the performance of less concentrated investments and the market as a whole.