Source: Parth Sanghvi
As the U.S. economic growth rate teeters towards the 2% threshold, investors are left grappling with how to safeguard their returns. In such situations, sector selection emerges as a potent tool in the investor’s arsenal. Market research firm Jefferies suggests a data-driven approach based on historical performance that reveals which sectors usually flourish and which ones falter during periods of below-average GDP expansion.
Even in the face of weak revisions and deeper cyclical cuts leading to a slash in its earnings forecasts, Jefferies remains steadfast in its current sector strategy. The firm’s strategy underscores a select group of outperformers and underperformers, identified based on the behavior of these segments during previous low-growth years.
Health Care as a Strong Contender in Sluggish Economies
The health care sector continues to demonstrate resilience even in the face of recent small-cap volatility. According to Jefferies, health care stocks have consistently delivered robust returns, often in double digits, during years of below-average GDP growth. This trend is discernible again in 2024, with the health care sector outperforming broader small-cap indices. This growth is bolstered, in part, by a surge in sub-$1 billion Mergers and Acquisitions (M&A) deals, which remain well above the trend.
Even though the health care sector has shown short-term underperformance, investors analyzing valuation multiples can discern that the sector’s Price to Earnings (P/E) ratio remains competitive. This competitiveness is especially evident when compared with overheated areas of the market, suggesting the long-term upside potential of the sector remains intact.
Defensive Strategy with Consumer Staples and Discretionary
Despite being underweight on both consumer staples and discretionary sectors due to balance sheet pressures and inflated valuations, Jefferies’ historical data suggests that these sectors usually perform well when economic growth is sluggish. The consumer staples sector benefits from consistent demand, and certain segments of the discretionary sector—especially those linked to low-ticket, habitual spending—have shown resilience even during contractionary periods.
Performance trends across both sectors, discernible through long-term sector historical data, corroborate the idea that defensiveness and selectivity—not broad exposure—are key to reaping returns from consumer names in a cooling economy.
Avoiding Underachievers: Energy and Communication Services
The chasm between the leading and lagging sectors widens dramatically when economic growth falls below 2%. This is especially noticeable in the energy sector, which has seen a near 30% fall since late November—worse than the typical early-recession declines. Communication services haven’t fared much better, remaining deeply in the red for the majority of the year.
These sectors are often tied to macro-sensitive inputs like global demand, commodity cycles, and advertising budgets—areas that tend to contract first and recover last in a slowing economy. Their weak earnings outlooks, coupled with the negative momentum observed in recent sector performance data, offer little reason for optimism in the near term.
What About the Remaining Sectors?
Small-cap earnings expectations for 2025 have taken a significant hit, particularly across cyclicals, energy, and materials. Utilities, once a reliable safe haven, now trade at the highest valuation among all sectors, followed closely by tech. Jefferies warns that these names may have become “crowded trades” driven by Exchange-Traded Fund (ETF) flows rather than fundamentals.
Conversely, Jefferies sees better valuation opportunities in financials and industrials—areas not as heavily bid up and still showing room for upside on a relative basis. Current sector-level P/E ratios support this case, showcasing more reasonable pricing in these segments compared to the richly valued defensives.
Final Thoughts
In a market characterized by sluggish growth and cautious sentiment, strategic positioning is crucial. The health care sector continues to deliver solid performance in soft economic environments, while selective opportunities remain in staples and discretionary—provided investors maintain vigilance for balance sheet strength and pricing discipline. On the other end of the spectrum, the energy and communication services sectors present structural and cyclical headwinds that make them difficult to justify in portfolios right now.
Leveraging historical data and real-time sector metrics to guide allocation decisions can help investors navigate low-growth periods with more clarity, resulting in better risk-adjusted outcomes.