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Welcome to RBCs Markets in Motion podcast, recorded December 3, 2024. I’m Lori Calvasina, Head of US Equity Strategy at RBC Capital Markets. Please listen to the end of this podcast for important disclaimers.
Today in the podcast, the early edition of our 2025 S&P 500 sector outlook.
The big things you need to know – with a focus on the sectors where we’ve made changes: First, we have upgraded Communication Services from market weight to overweight. Second, we are downgrading Health Care to market weight from over weight. Third, we are downgrading Materials from overweight to market weight.
If you’d like to hear more, here’s another 5 minutes.
Flip to slide 2 – sector performance
First, we are upgrading S&P 500 Communication Services to overweight from market weight, which we see as our fresh idea for 2025.
- The sector has been an in-line performer with the broader market since the US election.
- Sectors that we like have been tough to identify, and it’s fair to say with this one that the absence of negatives is a positive.
Flip to slide 3 – revisions
- We also like what we’re seeing in our earnings and valuation work for the broader sector and its major industries.
- On earnings, the sector has been strong relative to other sectors in terms of the rate of upward estimate revisions for both EPS and sales and the sensitivity of the sector’s EPS estimate revisions to a stronger US dollar is low relative to most other sectors.
Flip to slide 4 – Comm Svcs valuation
- On valuation, the median P/E of the sector is well below average relative to the broader market, and only slightly above average in absolute terms. Generally, the sector is one whose median P/E within the S&P 500 appears to be moving up off trough levels on both an absolute and relative basis.
Flip to slide 5 – defensive flows
- Flows to the Telecom sector as tracked by EPFR (the closest comparison for this sector) have recently turned positive as well, something we are also seeing for other growth sectors including Tech.
Flip to slide 6 – sentiment
- Communication Services also tends to outperform when consumer sentiment is rising, making it a potential beneficiary of better vibes in the new year.
Flip to slide 7 – election
- RBC’s US equity analysts had a modestly bullish tilt on their outlook for the sector in a Republican sweep in our pre-election survey work, though to a lesser degree than Financials and Energy.
- The key risk that we see to our call is that the sector tends to underperform when 10-year yields are rising.
Flip to slide 8 – dollar vs. revisions bar chart
Second, we are lowering S&P 500 Health Care to market weight from overweight.
- Health Care has been the worst S&P 500 sector post-election performer, though trends have stabilized in recent trading.
- We’ve liked this sector, and are generally inclined to look for opportunities amid dislocation, but we have too many questions about the sector’s future policy backdrop and so are moving to the sidelines.
- EPS and sales revisions trends for the sector remain positive and stronger than what we see in other sectors, but the sector tends to be one of the most sensitive ones in the S&P 500 to a stronger US dollar from an EPS revisions perspective.
Flip to slide 9 – HC valuation page
- On valuation, median P/Es for the sector are at historical lows relative to the broader market (making the case against an underweight) but are only around average relative to the S&P 500 (arguing more downside may remain).
- Flows to global Health Care funds are negative and show a deteriorating trend.
Flip to slide 10 – 10 year yields bar chart
- The sector also tends to underperform when 10-year yields are rising, and RBC’s Rate Strategy team currently expects 10-year yields to move higher through year-end 2025.
Flip to slide 11 – post election sector performance
- Looking back to past elections, the S&P 500 Health Care underperformed in the 12-month period after both the 2016 and 2020 contests.
Flip to slide 12 – china trade war bar chart
- One risk to our view: like other defensives, Health Care outperformed during the 2018 China trade war.
Third, we are lowering S&P 500 Materials to market weight from overweight.
- Materials was the worst S&P 500 sector performer during the China trade war of 2018, and our US analysts had a slightly negative tilt on the implications for their industry outlook under a Republican sweep in our pre-election survey.
- Meanwhile, earnings and sales revisions for Materials have been negative, and the sector tends to be one of the most sensitive to downward revisions when the US dollar strengthens.
Flip to slide 13 – materials valuations
- On valuation, the median P/E of the S&P 500 sector is a bit below average relative to the broader market (making an argument against being underweight) but is elevated on an absolute basis (adding to our desire to downgrade).
Flip to slide 14 – Materials flows
- Two risks to our downgrade (which also support keeping this sector at market weight not underweight): the improving flows to global Materials funds (which have also turned slightly positive)…
Flip to slide 15 – ISM bar chart
- …and its tendency to outperform when ISM manufacturing is on the rise (suggesting Materials could benefit if soft data improves).
Flip to slide 16 – sector view summary page
Before we sign off – a quick rundown on other sector views heading into the new year. We remain overweight Financials and Energy. We remain underweight Consumer Staples and REITs. And we remain market weight Industrials, Tech, Utilities, and Consumer Discretionary.
That’s all for now. Thanks for listening. And be sure to reach out to your RBC representative with any questions.