US large-cap equities: Focus shifts to earnings delivery

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.

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.

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