Which sector should investors back in 2025?

In recent years, the answer to ‘which sector’ has been unanimous — technology. Other sectors have shown strength – financials and utilities in 2024, for example – but none have had the consistency and potency of the technology sector. The Nasdaq is up another 35% over the past 12 months*, and the sector has looked unbeatable.

With this in mind, it is nerve-wracking not to suggest technology as one of the likely highlights for 2025. Every time investors have called the end of technology’s dominance, they have been wrong. Equally, technology seems unlikely to fall off a cliff: even the expensive Magnificent Seven have strong revenue growth and cash generation to support their valuations. However, many investors have a lot of exposure already, and as markets broaden out, there may be more compelling opportunities elsewhere. These are the areas to look at in the year ahead.

US Small Cap

There is still a lot to like about the US economy. It is forecast to grow 2.2% in 2025**, and may grow faster if Donald Trump’s plans for tax cuts, tariffs and deregulation have their desired impact. With that in mind, investors may want to retain exposure to the US market, but tweak exposure at the edges to balance out any overweight position in technology.

Olivia Micklem, co-manager on the Artemis US Smaller Companies fund, believes 2025 could see a revival for US smaller companies, building on a trend that started with the election. She says: “We continue to see some fantastic companies that we still think are undervalued. There are also a lot of different drivers that we think can continue to support a really strong rally in small-caps into 2025. These include a healthy economy, lower interest rates and continuing government investment in infrastructure. Trump’s pro-business agenda will also be of particular benefit to smaller companies as they tend to be domestically focused.”

US smaller companies aren’t as cheap as their UK peers, but they are cheap relative to US large-cap companies and have greater exposure to the domestic growth story in the US.

Listen on our podcast to Nish Patel, manager of the Global Smaller Companies Trust, who shares insights into current valuations, the impact of recent interest rate cuts, and how M&A and share buybacks are shaping the small-cap space.

Healthcare

It has been a frustrating year for investors in the healthcare sector. The sector has had plenty of factors in its favour – strong demographics, innovation, higher government spending – but this has failed to translate into higher share prices. The MSCI World Health Care index is up just 1.6% over the year, compared with a rise of 19.2% for the MSCI World index***. The US elections appear to have exerted a drag on sentiment.

James Douglas, manager on the Polar Capital Global Healthcare Trust, is forecasting a far better outcome in 2025. “This is not about market timing, however, or value sectors outperforming growth. It is about healthcare sector fundamentals – innovation and new products; untreated or underserved therapeutic categories; elevated utilisation levels; M&A activity – and other longer-term market dynamics including demographics and emerging markets. The opportunity is underpinned by what we believe are very attractive company valuations.”

Product approvals are high, with new launches across a range of conditions, including cancer, Alzheimer’s and obesity, and in medical devices. Emerging markets are also a source of higher returns as populations, incomes and wealth grow. He points out that between 2014 and 2040, global healthcare expenditure is forecast to increase from $9.2trn to $24trn, plus, “valuations are undemanding and allow for significant upside.” This may finally be realised in 2025.

Flexible fixed income

It is likely to be a complex year for fixed income. ‘All-in’ yields look attractive, but spreads for corporate bonds over government bonds look tight, and give little room for an economic slowdown. Inflation appears to be reviving and could build momentum if Donald Trump enacts his policy agenda in full. This could dent hopes of further interest rate cuts, which would be difficult for bond markets to digest.

Ariel Bezalel, manager of the Jupiter Strategic Bond fund, says many questions about the state of the US economy linger in the minds of investors: “Can the US Federal Reserve, which is well underway with its easing cycle, achieve a soft landing or are recessionary impulses still intact? Does the US economy’s resilience mask underlying problems? How will political changes in key countries affect policies? And what will be the role of geopolitics on commodity prices and inflation?”

This environment is likely to favour an opportunistic approach, with a fund manager who can find pockets of undervaluation in the market. A good strategic bond fund is likely to be a good option in the year ahead.

UK

Yes, it’s another prediction for the revival of the UK market. The UK saw a tentative recovery in 2024, but confidence took a hit from the uncertainty surrounding the new government’s fiscal plans. However, valuations remain cheap and there is strong support from merger and acquisition activity and share buybacks.

Simon Murray, manager of VT Tyndall Unconstrained UK Income, says: “We are optimistic about the outlook for UK equities in 2025, notwithstanding budgetary issues and concerns. The broad economic picture looks okay to us, consumers are in a reasonable spot, real wages are growing, unemployment is still at a low level, housing transactions are recovering. Inflation is at a more manageable level and interest rates are starting to come down.

“When we put those things together, we feel optimistic. What’s interesting is sentiment is so depressed.” As stock market performance starts to improve, and investors adjust to the new government, confidence may revive and the market could move quickly if it does.

Watch our 2025 outlook series

China

China remains an ‘out there’ choice, and there are still plenty of risks – from Trump tariffs to the flagging property market to ongoing consumer weakness. However, the Chinese stock market jumped higher in response to the stimulus announcement in November and has largely sustained this higher level. Valuations are cheap, and, while it still needs careful navigation, we still believe it is an area where good managers can make money.

Howard Wang, manager of the JPMorgan China Growth & Income Trust, says the upcoming annual NPC gathering in March 2025 will be a crucial event to monitor: “We will watch to see if Beijing announces more forceful fiscal stimulus measures to sustain growth into 2025, as current stimulus efforts may lose momentum in the new year.

“We continue to add to the consumer discretionary sector, which should benefit from increased household wealth due to stabilising housing prices. We are also increasing exposure to cyclical sectors like the EV battery space, where supply-and-demand dynamics are showing marginal improvement after a prolonged industry downturn.”

As ever, all predictions come with the caveat that the new year will almost certainly bring a range of unexpected events that could derail even the most carefully considered forecasts. There are a lot of unpredictable factors in the year ahead, particularly the new resident at the White House.

*Source: NASDAQ, total returns is us dollars, to 3 January 2025
**Source: International Monetary Fund, October 2024
***Source: MSCI index factsheet, 31 December 2024