Investment Strategy

Broadening rally is a healthy sign

Equity markets have been choppy but resilient in 2025 as investors assess the multitude of policy announcements that could impact sentiment or profitability, or both. In addition, fourth-quarter earnings season has been eventful with some stocks being greatly rewarded or severely punished depending on results relative to expectations.

Overall, however, revenue and profitability growth have exceeded Bloomberg consensus expectations for the S&P 500 Index, and 10 of 11 sectors have responded with gains on the year (see chart 1). This broadening in earnings and returns is a welcome sign and shows that while Information Technology is a heavyweight in the index, other sectors can drive positive performance.

Chart 1: Equity rally broadening in 2025Sources: Bloomberg and Wells Fargo Institute, February 18, 2025. YTD = year to date. Sector returns represented by the S&P 500 index sectors. An index is unmanaged and not available for direct investment. Past performance is no guarantee of future results.

Communication Services (which has a favorable rating in our guidance) led the way in 2024 and early in 2025 with strong fundamentals and reasonable valuations. Meanwhile, many cyclical sectors have rallied on improving profitability and anticipation of the new administration’s pro-growth policies. Specifically, Energy (most favorable), Financials (favorable), Industrials (favorable), and Materials (neutral) have all outperformed the S&P 500 Index in 2025. After a strong performance in 2024, Information Technology is lagging in 2025 with tariff concerns and questions around artificial intelligence (AI) weighing on prices. Even so, fundamentals remain strong and as valuations come in, we likely will look for opportunities to add on weakness.

Earnings should be key driver of returns

While S&P 500 Index earnings grew by 9% in 2024, the bulk of the 25% index return can be attributed to multiple expansion. With valuations near the top end of long-term ranges, we believe there’s limited upside to price-to-earnings multiples in 2025. Instead, our 2025 S&P 500 Index price target of 6600 likely will be driven by earnings growth we expect to be roughly 12%. We believe the pattern of outsized tech-related earnings growth is likely to continue in 2025 and 2026. However, the profit growth gap between growth and cyclical sectors likely will narrow over the next two years, as Bloomberg consensus estimates show broadening profitability across all sectors through 2026 (see chart 2).

Chart 2: Bloomberg consensus estimates show broad earnings growth through 2026Sources: Bloomberg and Wells Fargo Institute, Dec. 31, 2024, to Dec. 31, 2026, estimate, as of February 18, 2025. Sectors represented by S&P 500. An index is unmanaged and not available for direct investment. Past performance is not a guarantee of future results.

We’ve already seen some of this in fourth-quarter earnings results. The S&P 500 Index is tracking toward 6% revenue growth and 13% earnings growth for the fourth quarter, while margins are approaching record highs. Eight of 11 sectors have shown growth in profits. We believe this strength should carry over into 2025 as the economy grows and earnings growth broadens. And while tariffs do pose a risk to earnings, we expect that the combination of tax cut extension, deregulation, and the economy's organic strength will than offset negatives from tariffs.

In this environment, we lean toward quality and prefer U.S. over international and U.S. Large Cap Equities (favorable) over U.S. Mid Cap Equities (neutral) and U.S. Small Cap Equities (neutral). Overseas, we prefer Developed Market ex-U.S. (neutral) over Emerging Markets (unfavorable). Our sector guidance tilts toward cyclical and growth-oriented areas that should work in an economic recovery where long-term interest rates have been elevated and the consumer has remained resilient. We favor Communication Services, Energy, Financials, and Industrials. We are unfavorable on Consumer Staples and Utilities.

Implications of a steeper yield curve

The yield curve is a key indicator of the trajectory of economic growth, with a steep yield curve typically pointing to expectations for stronger economic growth while an inversion¹ points to expectations for slower economic growth. And while it is worth mentioning that the negative outcomes expected to follow its inversion did not materialize this market cycle, we believe important insights can be gained from recent trends in the curve.

As shown in the chart, the yield curve has steepened significantly since the peak of its inversion. In the intermediate portion of the curve, for example, yields increased from 3.3% to 4.4%,² while yields on maturities of one year or less saw notable declines. This steepening has played into our favorable view on the intermediate portion of the curve (five to seven years), where we believe investors can lock in attractive yields while limiting the price volatility and interest-rate risk of long-term fixed income.

While we see room for the yield curve to steepen further by year end and remain favorable on U.S. Intermediate Term Taxable Fixed Income, we also see the potential for heightened volatility. We therefore may see opportunities to add exposure to shorter or longer maturities in the event of material shifts in yields. Specifically, we would view 10-year Treasury yields at or above our year-end target range of 4.5% – 5.0% as a potential opportunity to add to U.S. Long Term Taxable Fixed Income positions and yields meaningfully below this range as a potential opportunity to add to U.S. Short Term Taxable Fixed Income positions.

Yield curve has steepened significantly since peak inversionSources: U.S Department of the Treasury and Wells Fargo Investment Institute. Data through May 4, 2023 to February 18, 2025. Peak inversion (May 4, 2023) based on 10-year minus 3-month Treasury yields. Yields represent past performance, which is no guarantee of future results, and fluctuate with market conditions.

¹ Yield curve inversion occurs when yields on the short end of the curve are higher than yields on the long end of the curve.

² Represents average of 5- and 7-year maturities.

An improving outlook for industrial metal prices

Industrial metals are beginning to show life again in 2025, as the Bloomberg Industrial Metals Subindex is up 6% year-to-date, as of February 14. Over the past two years, slowing global economic growth has been a major headwind, resulting in the sector being a relative underperformer. However, economic conditions appear to be improving in 2025, which we believe could translate into modestly stronger demand growth and sector returns.

Outside of our brighter economic growth outlook, industrial metal prices have risen in response to numerous tariff announcements over recent weeks. Given the U.S.’s heavy reliance on a variety of industrial metal imports (see chart), the announcement of tariffs has raised concerns over higher domestic prices and potential supply chain disruptions.

News over tariffs have certainly taken center stage in headlines, but in our view, the most important driver of industrial metal prices will be a more constructive economic growth outlook in 2025. An improving macro environment supports a more positive demand environment than seen in years past. In addition, we are beginning to see some improvements in manufacturing Purchasing Managers’ Indexes (PMIs), both globally and in the U.S., which is also typically a positive sign for demand growth.

The bottom line is that we are warming up to the neutrally rated industrial metals sector. While we see strengths in the brighter U.S. economic growth outlook, we still have concerns regarding China's struggling property sector, which has historically been a strong demand driver. These concerns explain why we are still neutral. However, given our expectations for industrial metal performance to catch up with the rest of the commodity complex amid an improving macro environment, we see opportunities to rotate commodity exposure into underweight positions in industrial metals.

U.S. net import reliance on various metals in Bloomberg’s Industrial Metals SubindexSources: United States Geological Survey and Wells Fargo Investment Institute. Annual data is for 2024 and calculated as net imports as a percentage of apparent domestic consumption. An index is unmanaged and not available for direct investment.

Private capital’s performance bifurcation continued

The elevated rate environment continued to benefit certain private capital strategies, while penalizing others in 2024. Income-oriented strategies, including Private Debt and Infrastructure, were among the beneficiaries, as investors sought resilient yields underpinned by elevated rates. With 9% to 11% returns, both strategies were top-performing private capital asset classes for the one-year period ending third-quarter 2024, outstripping their long-term performance averages (see chart).

Although the soft exit environment remained a challenge in 2024, select private equity strategies posted solid performance over the one-year period. Albeit still below their 10-year averages, buyout strategies recorded a solid 9.8% return for the one-year period ending third-quarter 2024 (see chart), while venture capital finally saw more positive quarters than negative ones over the same period. With early indications pointing to a positive fourth quarter, along with our outlook for rising public stock prices for 2025 and the prospect of a more deal-friendly regulatory environment, we believe private equity strategies have the potential to see further gains over the coming quarters.

Private Real Estate continued its transformation to a future regime. The asset class benefited from the Federal Reserve’s easing cycle and recorded its first positive quarter since third-quarter 2022. However, one-year performance remained negative and major real estate sectors, including industrial, residential, and office, are currently experiencing short-term oversupply challenges or longer-term headwinds.

To navigate the macroeconomic environment, given our outlook for gradual economic growth and elevated rates, we believe qualified investors should continue to focus on high-quality and resilient strategies, including Small/Mid Cap Buyout, Growth Equity, Distressed Credit, and Infrastructure.

Private capital 1-year and 10-year performanceSources: MSCI Burgiss and Wells Fargo Investment Institute. Data as of September 30, 2024. One-year and 10-year returns ended in the September. 30, 2024 Infrastructure is represented by Burgiss Infrastructure Index. Private Equity – Buyout is represented by Burgiss Private Equity Buyout index. Private Debt is represented by Burgiss Private Debt Index. Venture Capital is represented by Burgiss Venture Capital Index. Private Real Estate is represented by Burgiss Private Real Estate Index.

An index is unmanaged and not available for direct investment. Past performance is no guarantee of future results.

Alternative investments, such as hedge funds, private equity, private debt and private real estate funds are not appropriate for all investors and are only open to “accredited” or “qualified” investors within the meaning of U.S. securities laws.

Cash Alternatives and Fixed Income

Equities

Real Assets

Alternative Investments**

Source: Wells Fargo Investment Institute, February 24, 2025.

*Tactical horizon is 6-18 months

**Alternative investments are not appropriate for all investors. They are speculative and involve a high degree of risk that is appropriate only for those investors who have the financial sophistication and expertise to evaluate the merits and risks of an investment in a fund and for which the fund does not represent a complete investment program. Please see end of report for important definitions and disclosures.

Forecasts, estimates, and projections are not guaranteed and are based on certain assumptions and views of market and economic conditions which are subject to change.

Each asset class has its own risk and return characteristics. The level of risk associated with a particular investment or asset class generally correlates with the level of return the investment or asset class might achieve. Stock markets, especially foreign markets, are volatile. Stock values may fluctuate in response to general economic and market conditions, the prospects of individual companies, and industry sectors. Foreign investing has additional risks including those associated with currency fluctuation, political and economic instability, and different accounting standards. These risks are heightened in emerging markets. Small- and mid-cap stocks are generally more volatile, subject to greater risks and are less liquid than large company stocks. Bonds are subject to market, interest rate, price, credit/default, liquidity, inflation and other risks. Prices tend to be inversely affected by changes in interest rates. High yield (junk) bonds have lower credit ratings and are subject to greater risk of default and greater principal risk. The commodities markets are considered speculative, carry substantial risks, and have experienced periods of extreme volatility. Investing in a volatile and uncertain commodities market may cause a portfolio to rapidly increase or decrease in value which may result in greater share price volatility. Real estate has special risks including the possible illiquidity of underlying properties, credit risk, interest rate fluctuations and the impact of varied economic conditions.

Sector investing can be more volatile than investments that are broadly diversified over numerous sectors of the economy and will increase a portfolio’s vulnerability to any single economic, political, or regulatory development affecting the sector. This can result in greater price volatility. Communication services companies are vulnerable to their products and services becoming outdated because of technological advancement and the innovation of competitors. Companies in the communication services sector may also be affected by rapid technology changes; pricing competition, large equipment upgrades, substantial capital requirements and government regulation and approval of products and services. In addition, companies within the industry may invest heavily in research and development which is not guaranteed to lead to successful implementation of the proposed product. The Energy sector may be adversely affected by changes in worldwide energy prices, exploration, production spending, government regulation, and changes in exchange rates, depletion of natural resources, and risks that arise from extreme weather conditions. Materials industries can be significantly affected by the volatility of commodity prices, the exchange rate between foreign currency and the dollar, export/import concerns, worldwide competition, procurement and manufacturing and cost containment issues. There is increased risk investing in the Industrials sector. The industries within the sector can be significantly affected by general market and economic conditions, competition, technological innovation, legislation and government regulations, among other things, all of which can significantly affect a portfolio’s performance. Risks associated with the Technology sector include increased competition from domestic and international companies, unexpected changes in demand, regulatory actions, technical problems with key products, and the departure of key members of management. Technology and Internet-related stocks, especially smaller, less-seasoned companies, tend to be more volatile than the overall market.

Investing in gold, silver or other precious metals involves special risk considerations such as severe price fluctuations and adverse economic and regulatory developments affecting the sector or industry.

Alternative investments, such as hedge funds, private equity/private debt and private real estate funds, are speculative and involve a high degree of risk that is appropriate only for those investors who have the financial sophistication and expertise to evaluate the merits and risks of an investment in a fund and for which the fund does not represent a complete investment program. They entail significant risks that can include losses due to leveraging or other speculative investment practices, lack of liquidity, volatility of returns, restrictions on transferring interests in a fund, potential lack of diversification, absence and/or delay of information regarding valuations and pricing, complex tax structures and delays in tax reporting, less regulation and higher fees than mutual funds. Hedge fund, private equity, private debt and private real estate fund investing involves other material risks including capital loss and the loss of the entire amount invested. A fund's offering documents should be carefully reviewed prior to investing.

Hedge fund strategies, such as Equity Hedge, Event Driven, Macro and Relative Value, may expose investors to the risks associated with the use of short selling, leverage, derivatives and arbitrage methodologies. Short sales involve leverage and theoretically unlimited loss potential since the market price of securities sold short may continuously increase. The use of leverage in a portfolio varies by strategy. Leverage can significantly increase return potential but create greater risk of loss. Derivatives generally have implied leverage which can magnify volatility and may entail other risks such as market, interest rate, credit, counterparty and management risks. Arbitrage strategies expose a fund to the risk that the anticipated arbitrage opportunities will not develop as anticipated, resulting in potentially reduced returns or losses to the fund.

Bloomberg Industrial Metals Subindex is composed of futures contracts on aluminum, copper, nickel and zinc. It reflects the return of underlying commodity futures price movements only. It is quoted in US dollars.

Burgiss Infrastructure Index Burgiss infrastructure index includes funds that invest specifically in infrastructure, including roads, canals, airports, power lines, etc. The index is built by calculating the change in Net Asset Value of active funds in a given quarter, plus/minus aggregate cash flows for the cohort of funds included.

Burgiss Private Equity Buyout Index Burgiss buyout index includes equity funds that primarily focus on purchasing at least a controlling percentage of a company’s stock to take over its assets and operations. The index is built by calculating the change in Net Asset Value of active funds in a given quarter, plus/minus aggregate cash flows for the cohort of funds included.

Burgiss Private Debt Index Burgiss Private Debt indexes are defined as pools of capital raised for the purpose of lending to private companies, including those held by private equity funds, venture capital funds, real estate funds and infrastructure funds. The index is built by calculating the change in Net Asset Value of active funds in a given quarter, plus/minus aggregate cash flows for the cohort of funds included.

Burgiss Venture Capital Index Burgiss defines Venture Capital as pools of capital raised for the purpose of investing in the equity of startup companies. The index is built by calculating the change in Net Asset Value of active funds in a given quarter, plus/minus aggregate cash flows for the cohort of funds included.

Burgiss Private Real Estate Index Burgiss private real estate index includes funds investing in high quality properties for rental purposes. The index is built by calculating the change in Net Asset Value of active funds in a given quarter, plus/minus aggregate cash flows for the cohort of funds included.

Purchasing Managers Index (PMI) is an indicator of the economic health of the manufacturing sector. The PMI index is based on five major indicators: new orders, inventory levels, production, supplier deliveries and the employment environment.

S&P 500 Index is a market capitalization-weighted index composed of 500 widely held common stocks that is generally considered representative of the US stock market.

S&P 500 Communication Services Index comprises those companies included in the S&P 500 that are classified as members of the GICS® communication services sector.

S&P 500 Consumer Discretionary Index comprises those companies included in the S&P 500 that are classified as members of the GICS® consumer discretionary sector.

S&P 500 Consumer Staples Index comprises those companies included in the S&P 500 that are classified as members of the GICS® consumer staples sector.

S&P 500 Energy Index comprises those companies included in the S&P 500 that are classified as members of the GICS® energy sector.

S&P 500 Financials Index comprises those companies included in the S&P 500 that are classified as members of the GICS® financials sector.

S&P 500 Health Care Index comprises those companies included in the S&P 500 that are classified as members of the GICS® health care sector.

S&P 500 Industrials Index comprises those companies included in the S&P 500 that are classified as members of the GICS® industrials sector.

S&P 500 Information Technology Index comprises those companies included in the S&P 500 that are classified as members of the GICS® information technology sector.

S&P 500 Real Estate Index comprises those companies included in the S&P 500 that are classified as members of the GICS Real Estate sector.

S&P 500 Utilities Index comprises those companies included in the S&P 500 that are classified as members of the GICS utilities sector.

S&P 500 Materials Index comprises those companies included in the S&P 500 that are classified as members of the GICS® materials sector.

An index is unmanaged and not available for direct investment.

Global Investment Strategy (GIS) is a division of Wells Fargo Investment Institute, Inc. (WFII). WFII is a registered investment adviser and wholly owned subsidiary of Wells Fargo Bank, N.A., a bank affiliate of Wells Fargo & Company.

The information in this report was prepared by Global Investment Strategy. Opinions represent GIS’ opinion as of the date of this report and are for general information purposes only and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally. GIS does not undertake to advise you of any change in its opinions or the information contained in this report. Wells Fargo & Company affiliates may issue reports or have opinions that are inconsistent with, and reach different conclusions from, this report.

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