CIO Insights: Where to find “FAT” potential in US equities

10 minute read

The US stock market was the best performer among major global markets in 2024, with the S&P 500 up 25% versus a 6% gain for global equities outside the US. But that headline growth had a lot of variation under the surface. While Big Tech led the charge, other sectors posted more mixed performance.

In this month’s CIO Insights, we take a closer look at US equity sectors: applying our "FAT" framework to examine how fiscal policy, AI adoption, and Trump's return to office could shape performance in the year ahead.

Key takeaways:

• In 2024, variations in US sector performance was largely driven by earnings growth. While many investors focused on higher valuations as a driver of US equity returns last year, earnings growth was also key – with S&P 500 earnings growing 9.5%. This was particularly evident in sector performance: those with stronger EPS growth were rewarded with stronger price returns.
• In 2025, earnings expectations and valuations reveal where the opportunities and risks are in US sectors. Market consensus points to another solid year for US equities, with growth mostly driven by a handful of sectors, like information technology and health care. Going one layer deeper, comparing a sector's valuation against its expected earnings growth provides insight into which may be underpriced or overpriced.
• Our “FAT” framework highlights potential upside and downside risks for various sectors. Broader macro trends can heavily influence the degree to which sectors meet, beat, or miss earnings expectations. Using our “FAT” framework, we see the impact of expansionary fiscal policy, artificial intelligence adoption, and the re-election of Donald Trump contributing to tailwinds for tech-related sectors and financials, and headwinds for consumer staples and real estate.

In 2024, differences in US sector performance were largely driven by differences in earnings

Before we look to 2025, let’s review how US equities performed in 2024. Many investors were focused on US stocks being expensive over the past year, as valuations expanded on the back of resilient economic growth, Federal Reserve (Fed) interest rate cuts, and improving investor sentiment. Those forces contributed to the S&P 500’s price-to-earnings (P/E) ratio rising to 21.7x by the end of 2024, versus 19.7x at the start of the year.

But beneath the headline figures, there was a lot of variation among individual sectors. Ultimately, differences in sector performance were mostly driven by their earnings growth –  sectors with higher earnings enjoyed higher returns, as shown in Chart 1. At the top-right corner, we see the communication services sector with the highest earnings growth (21.7%) and the highest price gains (38.9%). Conversely, the materials sector in the bottom-left corner posted an earnings contraction (-9.5%) and negative returns (-1.8%).

Our takeaway: sector performance last year came down to the fundamentals, with differences in earnings growth explaining the bulk of the differences in returns. For those interested in the technical details, the R-squared – or how much one variable (price change) can be explained by its relationship with another variable (earnings growth) – was 73%.

(For more on market performance and our portfolios in 2024, see StashAway’s 2024 Returns: Capturing growth over a year of diverging global markets.)

Sector valuations and earnings expectations show where the opportunities and risks are in 2025

Looking to the year ahead, market consensus sees another solid year for US equities, or 15% earnings growth for the S&P 500, based on estimates from FactSet. That’s driven by strong expectations for a handful of sectors – including information technology (with projected growth of 23%), health care (20%), and industrials (19%).

Given these expectations, examining sector valuations can provide insight into where the opportunities and risks lie. Chart 2a below illustrates this dynamic, where sectors can be broadly grouped into four categories based on their forward price-to-earnings (P/E) ratio and earnings growth relative to the overall market.

This analysis reveals potential opportunities in sectors offering higher earnings expectations and lower valuations compared to the broader S&P 500 (those in the “under-priced growth”, top-left quadrant). That’s because the growth potential of such sectors – like communication services, health care, or materials – may not be fully priced in by the market. If these sectors deliver on expectations, investors could benefit from both earnings growth and valuation re-rating as market pricing adjusts to reflect their fundamentals.

On the other hand, those that are more richly valued but with lower earnings prospects (or those with “low growth, high expectations” in the bottom-right quadrant) may be more vulnerable – especially if they miss those expectations.

Our “FAT” framework highlights the potential for surprises 

Many investment analysts take a bottom-up approach to come up with their earnings projections. That means carefully reviewing company statements and analysing industry dynamics that could impact revenue and margins in the quarters ahead. But broader changes in macro trends often influence how these forecasts eventually play out. One good recent example: investments in AI infrastructure, which helped the semiconductor sector beat expectations over the past two years.

In our 2025 Macro Outlook: “FAT” is the new normal, we explained three forces that could shape the macro and market landscape in the years ahead:

• Fiscal policy taking a more prominent role in the economic cycle,
• Artificial intelligence seeing increased adoption, and
• Trump’s policy agenda – from tax cuts to tariffs – taking shape.

Using this framework, Table 1 below outlines where we see scope for positive and negative surprises for US equity sector earnings. We rated each sector along each of the three “FAT” pillars: upside potential is coloured in green, while downside risks are in red.

(The full, detailed table can be found in the Appendix at the end of this article.)

Additionally, we can layer these ratings on top of our earlier chart of sector valuations – this is illustrated in Chart 2b below.

Tech-related sectors, financials have the biggest scope for positive surprises

In terms of positive impact, we’ve assessed that tech-focused sectors – like communication services and information technology – and financials have the strongest potential to see upside in earnings as a result of these forces:

• For sectors like communication services and information technology, a higher-for-longer interest rate environment may be a net positive for mega-cap tech firms, given their large cash holdings and low debt levels. AI advancements are also a strong source of support – Chart 3 below shows Moody's assessment of where the technology could have a positive impact on credit quality, which is ultimately reflective of improved company fundamentals. Additionally, Trump’s stance toward deregulation should stimulate merger and acquisition (M&A) activity and growth in the sector.

• For financials, more expansionary fiscal policy could mean stronger credit growth and a steeper yield curve – both positive for bank revenues and margins. Rapid adoption of AI in banks and Trump’s focus on deregulation and tax cuts are also supportive of the sector. Given the sector’s more muted earnings prospects and lower valuations relative to the broader S&P 500, these forces may be catalysts to exceed those expectations.

Consumer staples, real estate may be more exposed to downside risks

On the other end of the spectrum, we see downside risks for the consumer staples sector and real estate based on our “FAT” framework:

• For the consumer staples sector, higher interest rates and inflation are a negative for consumer spending, and could further squeeze the sector’s generally thin profit margins. The threat of tariffs and more restrictive immigration policies also add risk to margins, given the potential for higher input costs. While current valuations do reflect lower earnings expectations, they remain close to that of the broader S&P 500 – suggesting the risk of a pullback in prices should valuations adjust downward.

• For the real estate sector, a higher rate environment may be particularly challenging as it reduces property demand and valuations. The REITs sub-sector is also exposed to higher borrowing costs, which reduces profitability – though that may be offset by tax cuts. On valuations, the sector’s lower growth prospects are also currently priced in.

Staying “FAT” in the year ahead

The real story of investing often lies beneath the news headlines. While broad market indices paint a useful big picture, a closer look often reveals different stories playing out across the various sectors. Understanding how major macro forces could impact different sectors helps to identify where further value might emerge in 2025.

StashAway’s General Investing portfolios are already positioned to capture growth across key sectors via diversified exposure. Our investment framework, ERAA®, also tilts US sector allocations according to prevailing macroeconomic conditions – for example, by giving more weight to industrials, which tend to perform well under the current regime of inflationary growth.

In addition, our Flexible Portfolios offer access to over 70 ETFs, including individual US sectors and sub-sectors, so that you can also fine-tune your exposures based on your view of how these "FAT" forces might play out.

And finally, remember that while market narratives may evolve, the fundamentals of successful long-term investing remain constant: maintaining a well-diversified portfolio aligned with your financial goals. With that core principle in mind, you can position yourself for whatever 2025 – and beyond – may bring.

Glossary

Earnings per share (EPS)

A company's profit divided by its outstanding shares. A key metric for measuring a company's profitability and comparing companies of different sizes.

Forward price-to-earnings ratio (P/E)

A ratio that compares a company's current stock price to its predicted earnings per share for the next 12 months. A higher P/E ratio suggests investors expect higher earnings growth.

Market consensus

The average of forecasts by analysts on future metrics like earnings growth. It typically represents a collective view of what the market is expecting.

Appendix

An analysis of US sectors based on the pillars of our "FAT" framework