Investing.com -- RBC Capital Markets on Tuesday reiterated an Overweight rating on Financials and Energy sectors heading into 2025 and upgraded Communication Services.
The Financials sector has staged a strong performance following the 2024 election, with RBC analysts having predicted significant tailwinds in the event of a Republican sweep. Positive factors for Financials include potential corporate tax cuts, an uptick in mergers and acquisitions, and deregulation.
The sector has seen upward revisions in earnings per share (EPS) and sales estimates, and it benefits from low sensitivity to the stronger US dollar.
“If soft data like consumer sentiment and ISM manufacturing show improvement in the new year, as many expect, this sector also seems likely to benefit as historically it has tended to outperform when both of these indicators are moving higher,” RBC strategists said.
“It’s also worth noting that Financials outperformed in the 12-month period following the last two presidential elections in 2016 and 2020 and saw one of the biggest reductions to its effective tax rate after Trump’s tax reform package passed in 2017.”
Meanwhile, the sectors’ valuations have turned expensive on an absolute basis within the S&P 500, though RBC believes they remain reasonable when compared to the broader market.
The investment bank also continues to favor the Energy sector, describing it as a contrarian pick. While post-election gains have diminished, the sector is still attractive due to strong tailwinds from a Republican sweep, appealing valuations, and a lower bar for EPS revisions heading into the new year.
Energy's EPS revisions are less affected by a stronger US dollar, and global Energy fund flows are showing signs of recovery.
“The main risk we see to our Energy overweight is that the sector underperformed during the 2018 China trade war along with other commodity and cyclically oriented old economy sectors,” strategists pointed out.
Lastly, RBC upgraded Communication Services to Overweight. The firm highlights that the sector's median price-to-earnings (P/E) ratio is below the market average, and recent consensus forecasts for 2024 have improved.
Communication Services also benefits from low sensitivity to US dollar strength and tends to outperform with rising consumer sentiment.
In terms of valuation, the median P/E of the sector is significantly below the average relative to the broader market, RBC notes, and just 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,” the note states.
“Like Financials, Communication Services also tends to outperform when consumer sentiment is rising, making it another potential beneficiary of better vibes in the new year.”
The biggest risk that RBC sees to its upgrade is that Communication Services tends to underperform when 10-year yields are on the rise.