The stock market delivered robust returns in 2024, gaining 23% and notching back-to-back years of greater than 20% returns.
That’s pretty impressive, given the S&P 500’s historical average annual return is closer to 10%. But remember, those returns reflect gains across a wide swath of stocks, crisscrossing various parts of the market. Remarkably, some sectors delivered even higher returns.
For instance, those savvy enough to look beyond the naysayers and stash money in the technology sector were particularly well rewarded. The iShares Technology ETF (XLK) delivered a whopping 30.25% return in 2024.
Of course, the past doesn’t guarantee the future, so investors are right to wonder if technology can continue its winning ways or if there’s another place better to park their hard-earned cash.
Fortunately, Goldman Sachs just revealed its favorite sectors to overweight in 2025, making it a little easier to decide whether to stay put or shift to other baskets.
Goldman Sachs crunches data, picks best sectors for 2025
The Goldman Sachs’ research team recently launched a sector model for U.S. equities, which recommends “high conviction” overweights based on the probability that an equal-weighted sector outperforms the equal-weighted S&P 500 by five percentage points or more over the following six months.
Its model typically suggests that three sectors should be overweight for the six months ahead.
So far, the model's results are intriguing. A back test showed it outperformed the S&P 500 by a 6-month average of 8% since 2004.
Of course, this testing assumes perfect foresight for the model's inputs, such as macroeconomic variables, including economic growth. Still, those are robust returns.
Goldman Sachs' sector overweights for 2025 could similarly deliver gains, but Goldman admits there are challenges to forecasting this year's likely winners. Much could depend on economic growth.
The firm's economists forecast “above-trend and above-consensus U.S. economic growth, which, coupled with potential fiscal policy changes, generally supports a cyclical posture.”
However, they also expect economic growth to decelerate slightly, and stocks have arguably already priced in an extremely optimistic growth backdrop. After all, stocks aren’t cheap after the past two years of outsized returns.
Goldman Sachs issues outlook for 2025
As part of its analysis, Goldman's team provided their outlook for a number of different macro-economic data:
GDP: Goldman's economists expect economic growth to be above trend and above consensus, but it will decelerate slightly in 2025 relative to 2024. GS Economics forecasts real GDP growth of 2.5% in 2025, compared with 2.8% in 2024.
Interest rates: The firm's strategists believe market pricing is slightly too hawkish. They forecast the nominal 2-year US Treasury yield will fall modestly from current levels by year-end 2025, and the nominal 10-year yield will broadly remain in its recent trading range in 2025. Their forecast implies a steepening of the yield curve.
US Dollar: FX strategists expect the dollar will strengthen modestly in 2025, driven by the combination of strong US economic growth relative to other nations and potential tariff policies.
Commodities: Its commodity experts expect oil prices to be range-bound between $70 and $85 per barrel, with risks tilted to higher prices in the short term and lower prices in the long term. However, they forecast higher prices for metals like copper and gold.
Goldman Sachs's favorite stock market sectors, including software
Goldman Sachs sector model incorporates:
Macro Data: Economic growth, unemployment, interest rates, the trade-weighted U.S. Dollar, and oil prices.
Fundamental Data: Consensus earnings growth, profit margins, and return on equity.
Valuation: Price to earnings (P/E), price to book (P/B), Enterprise value to earnings before interest, taxes, depreciation, and amortization (EV/EBITDA), and enterprise value to sales (EV/sales).
Based on all of the various inputs, Goldman Sachs' analysts recommend overweighting in portfolios the following sectors:
Materials,
Software & Services,
Health Care,
Utilities, and
Real Estate
The model’s highest-conviction picks out of the five are Materials and Software & Services. Note that the sector model breaks the Information Technology and Communication Services sectors into their various industry groups to better reflect the varied businesses. The sample period utilized includes 2004-2018.
In 2024, the S&P 500 iShares Basic Materials ETF (XLB) produced a negative 4.53% return versus a positive 23% for the S&P 500 Index. The S&P 500 basic materials sector ended last year at a forward 12-month price to earnings, or P/E, level of 18.3x versus a 20-year average of 15.2x.
However, looking ahead, Goldman Sachs forecasts that the sector: 1) should generate 13% EPS growth in both 2025 and 2026; 2) currently trades at an 8% valuation discount versus the S&P 500; and 3) looking back over the past 20 years, valuation for the sector sits in just the 18% percentile. The largest three stocks by market cap in the sector include Lin plc (21.5%), Sherwin Williams (8.3%), and Air Products & Chemicals Inc. (6.8%).
Turning to software, the iShares Technology Software ETF (IGV) (using this as a proxy for software companies) generated a return of 23.41% in 2024.
Within software stocks, there was a fairly wide range of dispersion between winners and losers last year. While the valuation level for software stocks is currently on the high side (note: software currently trades at a 68% premium versus the S&P 500 and is in the 90% percentile rank looking back over the past 20 years), Goldman Sachs highlights that: 1) EPS for the industry is currently forecast to grow 10% and 14% in 2025 and 2026; 2) the group has a long-term estimated growth rate of 14% and 3) the sector currently boasts the highest return on equity (31%) and net margin (28%) of all S&P 500 sectors.
Growth and spending on AI will likely fuel additional gains in several software stocks in the year ahead.
Many of the largest software and communication stocks, such as Microsoft Corp, ServiceNow Inc., Salesforce Inc., Adobe Inc., and Oracle Corp., along with names like Meta Platforms and Netflix Inc., are already spending significant amounts of money on AI. AI trends will likely continue benefiting a wide range of software and communication-related names this year.
According to a recent industry forecast from International Data Corporation - IDC, "The rapid incorporation of AI, and generative AI (GenAI) in particular, into a wide range of products will result in a compound annual growth rate (CAGR) of 29.0% over the 2024-2028 forecast period."
Something else to keep in mind
Heading into 2025, the Goldman Sachs model favors more defensive market segments. This is partly due to the high level of optimism that has already been priced into equity markets.
Goldman Sachs points out, however, that historically, when there was a Republican sweep in Washington, as we have seen this time, cyclicals outperformed defensives by 5.4%.
According to the analysts, while the economic backdrop currently favors cyclical over defensive sectors, the equity market is now pricing in growth above and beyond current economic forecasts. As a result, this dynamic favors more defensive parts of the market heading into 2025.
