U.S. large-cap equities: Focus shifts to earnings delivery
Portfolio Manager Jeremiah Buckley shares his 2025 outlook for U.S. large-cap equities, highlighting positive earnings trends and economic strength. He also discusses why the market may increasingly differentiate between companies delivering on growth expectations and those falling short and explains why companies investing in innovation and growing market share are positioned to stand out.
5 minute read
Key takeaways:
- The outlook for U.S. large-cap equities remains positive, supported by continued earnings growth, strong consumer spending, and healthy labor markets. However, the S&P 500® Index’s 2024 gains have outpaced earnings growth, leading to higher valuations.
- Rising valuations suggest the market will increasingly differentiate between companies delivering on earnings expectations and those falling short. Selectivity is particularly important across sectors, and within subsectors, where stock prices have risen without corresponding earnings growth.
- In our view, companies investing in innovation and gaining market share can drive sustained incremental earnings growth. These firms may be better positioned if economic growth falls short of optimistic forecasts, compared with competitors that depend more heavily on broad economic expansion.
Strong earnings and resilient economic growth fueled U.S. equity market gains in 2024. While technology and communication services stocks led both earnings and performance gains, market leadership broadened as cyclical sectors like financials and industrials gained momentum.
The outlook for U.S. large-cap equities remains positive, supported by ongoing earnings growth and economic strength. However, it’s important to note that the S&P 500’s 2024 rise has outpaced earnings growth. This makes selectivity important across sectors, and within subsectors, where valuations have expanded. In our view, a company’s ability to deliver growth that justifies its valuation may be a key determinate of performance in 2025.
A supportive economic backdrop
The U.S. economy is on solid footing, with moderate growth supported by a strong consumer and healthy labor markets. Rising disposable personal income, stock market gains, higher interest on cash, and real wage growth point to healthy consumer spending ahead. Corporate profit margins have held up, suggesting limited likelihood of mass layoffs. Furthermore, the Federal Reserve (Fed) can deploy stimulative policies if needed, supporting expectations of a soft landing.
A particularly encouraging development is the recent resurgence in labor productivity (Figure 1). This often-overlooked economic driver enables companies to increase wages while maintaining profit margins. In turn, this wage growth supports robust consumer spending, a crucial engine for the economy. We believe this uptick in productivity is set to continue due to the innovations and artificial intelligence (AI) productivity gains we are witnessing across sectors.
Figure 1: Labor productivity rebound
Since the third quarter of 2022, the U.S. Labor Productivity index has climbed for eight consecutive quarters following three quarterly declines.
Source: U.S. Bureau of Labor Statistics, Nonfarm Business Sector: Labor Productivity (Output per Hour) for All Workers. Index 2017 = 100, quarterly frequency, seasonally adjusted. Data as at 7 November 2024.
In terms of economic risks, we are monitoring the concentrated nature of recent job gains in specific sectors like hospitality, healthcare, government, and construction, as overall job growth could be constrained by limited participation.
Tech and other growth opportunities
Looking at specific opportunities, AI remains a compelling theme despite recent volatility in related stocks. Fundamental signals are strengthening, with increased capital spending and robust demand for graphics processing units (GPUs) and AI-related infrastructure. We maintain a positive view on hyperscalers and semiconductor infrastructure stocks, whose valuations appear reasonable given their growth trajectories and logical capital spending plans.
Outside of technology, we believe healthcare stocks present attractive growth prospects and reasonable valuations, particularly in the biotech and medical device subsectors, where scientific breakthroughs are enabling several new treatments.
Additionally, we see compelling opportunities in consumer services and financial services. The strong labor market bodes well for consumer discretionary spending, particularly in travel and hospitality. In financials, we’re positive on the continued shift from cash to card-based payments as well as financial services companies that stand to benefit from increased capital markets activity.
Utilities, with improving growth prospects and attractive dividend levels, are another area of interest. Accelerating data center electricity demand and the electrification trend more broadly are driving higher long-term earnings growth guidance for the sector.
Focus on innovative, market share-gaining companies
While we maintain a positive outlook on U.S. large-cap equities, selectivity is key. In 2025, we expect the market to increasingly differentiate between companies delivering on earnings expectations and those falling short. Some sectors that rallied on interest rate declines or election optimism, particularly banks and capital goods companies, have seen multiple expansion without corresponding earnings upgrades, making their valuations vulnerable.
Also, market prices in some sectors reflect expectations of accelerated economic growth under the new administration’s pro-growth policies. However, we believe a more likely scenario is consistent economic activity that supports a soft landing. Therefore, we are focused on where multiple expansion is warranted by fundamental strength versus where it merely reflects temporary optimism.
In our view, companies investing in innovation and gaining market share will stand out from competitors. These firms’ ability to generate internal growth provides a buffer against valuation pressure if the economy doesn’t accelerate, unlike competitors who tend to rely more heavily on broader economic conditions to drive earnings growth. We believe high-quality growth firms with differentiated products can drive sustained earnings growth across various economic scenarios in 2025 and beyond.
S&P 500® Index reflects U.S. large-cap equity performance and represents broad U.S. equity market performance.
Volatility measures risk using the dispersion of returns for a given investment.
IMPORTANT INFORMATION
Equity securities are subject to risks including market risk. Returns will fluctuate in response to issuer, political and economic developments.
Growth stocks are subject to increased risk of loss and price volatility and may not realize their perceived growth potential.
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.
These are the views of the author at the time of publication and may differ from the views of other individuals/teams at Janus Henderson Investors. References made to individual securities do not constitute a recommendation to buy, sell or hold any security, investment strategy or market sector, and should not be assumed to be profitable. Janus Henderson Investors, its affiliated advisor, or its employees, may have a position in the securities mentioned.
Past performance does not predict future returns. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested.
The information in this article does not qualify as an investment recommendation.
There is no guarantee that past trends will continue, or forecasts will be realised.
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Specific risks
- Shares/Units can lose value rapidly, and typically involve higher risks than bonds or money market instruments. The value of your investment may fall as a result.
- An issuer of a bond (or money market instrument) may become unable or unwilling to pay interest or repay capital to the Fund. If this happens or the market perceives this may happen, the value of the bond will fall.
- When interest rates rise (or fall), the prices of different securities will be affected differently. In particular, bond values generally fall when interest rates rise (or are expected to rise). This risk is typically greater the longer the maturity of a bond investment.
- Emerging markets expose the Fund to higher volatility and greater risk of loss than developed markets; they are susceptible to adverse political and economic events, and may be less well regulated with less robust custody and settlement procedures.
- The Fund may use derivatives to help achieve its investment objective. This can result in leverage (higher levels of debt), which can magnify an investment outcome. Gains or losses to the Fund may therefore be greater than the cost of the derivative. Derivatives also introduce other risks, in particular, that a derivative counterparty may not meet its contractual obligations.
- If the Fund holds assets in currencies other than the base currency of the Fund, or you invest in a share/unit class of a different currency to the Fund (unless hedged, i.e. mitigated by taking an offsetting position in a related security), the value of your investment may be impacted by changes in exchange rates.
- When the Fund, or a share/unit class, seeks to mitigate exchange rate movements of a currency relative to the base currency (hedge), the hedging strategy itself may positively or negatively impact the value of the Fund due to differences in short-term interest rates between the currencies.
- Securities within the Fund could become hard to value or to sell at a desired time and price, especially in extreme market conditions when asset prices may be falling, increasing the risk of investment losses.
- The Fund could lose money if a counterparty with which the Fund trades becomes unwilling or unable to meet its obligations, or as a result of failure or delay in operational processes or the failure of a third party provider.
Specific risks
- An issuer of a bond (or money market instrument) may become unable or unwilling to pay interest or repay capital to the Fund. If this happens or the market perceives this may happen, the value of the bond will fall.
- When interest rates rise (or fall), the prices of different securities will be affected differently. In particular, bond values generally fall when interest rates rise (or are expected to rise). This risk is typically greater the longer the maturity of a bond investment.
- The Fund invests in high yield (non-investment grade) bonds and while these generally offer higher rates of interest than investment grade bonds, they are more speculative and more sensitive to adverse changes in market conditions.
- Some bonds (callable bonds) allow their issuers the right to repay capital early or to extend the maturity. Issuers may exercise these rights when favourable to them and as a result the value of the Fund may be impacted.
- The Fund may use derivatives to help achieve its investment objective. This can result in leverage (higher levels of debt), which can magnify an investment outcome. Gains or losses to the Fund may therefore be greater than the cost of the derivative. Derivatives also introduce other risks, in particular, that a derivative counterparty may not meet its contractual obligations.
- If the Fund holds assets in currencies other than the base currency of the Fund, or you invest in a share/unit class of a different currency to the Fund (unless hedged, i.e. mitigated by taking an offsetting position in a related security), the value of your investment may be impacted by changes in exchange rates.
- When the Fund, or a share/unit class, seeks to mitigate exchange rate movements of a currency relative to the base currency (hedge), the hedging strategy itself may positively or negatively impact the value of the Fund due to differences in short-term interest rates between the currencies.
- Securities within the Fund could become hard to value or to sell at a desired time and price, especially in extreme market conditions when asset prices may be falling, increasing the risk of investment losses.
- The Fund could lose money if a counterparty with which the Fund trades becomes unwilling or unable to meet its obligations, or as a result of failure or delay in operational processes or the failure of a third party provider.
- In addition to income, this share class may distribute realised and unrealised capital gains and original capital invested. Fees, charges and expenses are also deducted from capital. Both factors may result in capital erosion and reduced potential for capital growth. Investors should also note that distributions of this nature may be treated (and taxable) as income depending on local tax legislation.
Specific risks
5 minute read
Key takeaways:
- The outlook for U.S. large-cap equities remains positive, supported by continued earnings growth, strong consumer spending, and healthy labor markets. However, the S&P 500® Index’s 2024 gains have outpaced earnings growth, leading to higher valuations.
- Rising valuations suggest the market will increasingly differentiate between companies delivering on earnings expectations and those falling short. Selectivity is particularly important across sectors, and within subsectors, where stock prices have risen without corresponding earnings growth.
- In our view, companies investing in innovation and gaining market share can drive sustained incremental earnings growth. These firms may be better positioned if economic growth falls short of optimistic forecasts, compared with competitors that depend more heavily on broad economic expansion.
