The stock market has been on a tear in recent years, and 2024 was no exception. The S&P 500 delivered robust returns of 23%, notching back-to-back years of greater than 20% returns. This is particularly impressive when you consider that the historical average annual return for the S&P 500 is closer to 10%.
Sector Performance
While some sectors delivered higher returns, those savvy enough to invest in technology saw significant gains. The iShares Technology ETF (XLK) delivered a whopping 30.25% return in 2024.
Goldman Sachs’ Sector Model
But what about the future? Goldman Sachs has released its sector model for U.S. equities, which recommends overweighting certain sectors based on their probability of outperforming the S&P 500 by five percentage points or more. The highest-conviction picks from the model are Materials and Software & Services.
Materials Sector
In 2024, the S&P 500 basic materials sector produced a negative 4.53% return compared to a positive 23% for the S&P 500 Index. However, Goldman Sachs forecasts that the sector will generate 13% EPS growth in both 2025 and 2026, and currently trades at an 8% valuation discount versus the S&P 500.
Software Sector
Within software stocks, there was a wide range of dispersion between winners and losers last year. While the valuation level for software stocks is currently on the high side, Goldman Sachs highlights that EPS growth is expected to be 10% in 2025 and 14% in 2026, with a long-term estimated growth rate of 14%.
AI and Software Stocks
Many of the largest software and communication stocks are already spending significant amounts of money on AI. This trend will likely continue benefiting a wide range of software and communication-related names this year.
Additional Forecasts for 2025
- A recent industry forecast from International Data Corporation – IDC predicts that AI will result in a compound annual growth rate (CAGR) of 29.0% over the 2024-2028 forecast period.
- Goldman Sachs points out that historically, when there was a Republican sweep in Washington, cyclicals outperformed defensives by 5.4%.
Conclusion
The stock market has delivered robust returns in recent years, and Goldman Sachs’ sector model suggests that Materials and Software & Services will be among the top performers in 2025. However, it’s worth noting that historically, when there was a Republican sweep in Washington, cyclicals outperformed defensives by 5.4%.
Recommendations
- Consider overweighting Materials and Software & Services sectors based on Goldman Sachs’ sector model.
- Focus on software stocks with high growth potential and significant spending on AI.
- Consider more defensive market segments due to the high level of optimism that has already been priced into equity markets.
Note: The information provided is for educational purposes only and should not be considered as investment advice.
