As the U.S. economy slows toward the critical 2 percent growth threshold, strategic sector selection emerges as an essential tool for investors aiming to protect their returns. Jefferies provides insight into this matter by analyzing historical performance data, revealing which sectors traditionally thrive during periods of subpar GDP growth and which ones falter.

Despite a downward adjustment in earnings forecasts due to disappointing revisions and deeper cyclic cuts, Jefferies remains committed to its current sector strategy. The firm emphasizes a select group of outperforming sectors while identifying key underperformers based on their historical performance during low-growth periods.

Health Care: A Beacon of Stability in Economic Slump

The health care sector continues to demonstrate resilience, even amid the recent volatility in small-cap stocks. Jefferies notes that during periods of below-average GDP expansion, health care stocks have often yielded impressive returns, frequently in the double digits. This trend appears set to continue into 2024, with health care outperforming broader small-cap indices, supported partially by an increase in mergers and acquisitions involving companies valued at under $1 billion.

Even amidst short-term setbacks, current valuation multiples indicate that health care stocks maintain a competitive P/E ratio compared to overheated sectors, suggesting there is considerable long-term upside potential.

Resilience in Consumer Staples and Discretionary Sectors

Jefferies has adopted an underweight position on consumer staples and discretionary sectors due to stretched valuations and balance sheet constraints. However, historically, these sectors tend to perform well in times of economic softness. Consumer staples face stable demand, while certain discretionary categories—especially those linked to low-cost, routine spending—have held up relatively well, even in downturns.

Performance trends in both sectors indicate that a conservative and selective approach—rather than broad exposure—is crucial for capturing returns within consumer sectors in a cooling economy.

Navigating Away from Underperformers: Energy and Communication Services

The disparity between leading and lagging sectors becomes stark when growth dips below 2%. Notably, the energy sector has plummeted by nearly 30% since late November, outpacing typical initial recession declines. Communication services have similarly struggled, remaining substantially in the red throughout the year.

These sectors often depend on macroeconomic factors such as global demand, commodity cycles, and advertising budgets—areas that are prone to early contraction in a slowing economy. The grim earnings forecasts, coupled with negative momentum reflected in sector performance metrics, provide little optimism for these sectors in the short term.

Current Trends and Future Outlook

Expectations for small-cap earnings in 2025 have dropped significantly, especially in cyclicals, energy, and materials. Utilities, which were once considered a reliable source of stability, now carry the highest valuations among all sectors, followed closely by tech, indicating they may be overly warmed by ETF inflows rather than fundamentals.

Jefferies identifies better valuation opportunities in financials and industrial sectors—areas that are not excessively bid up and are still showing relative upside potential. Current sector-level P/E ratios reinforce this claim, as they suggest reasonable pricing in these segments compared to significantly overvalued defensive stocks.

Final Thoughts

In a market characterized by muted growth and cautious sentiment, strategic positioning holds paramount importance. Health care consistently yields strong performance in sluggish environments, while select opportunities still exist within staples and discretionary—and investors need to be vigilant about balance sheets and pricing strategies. In contrast, energy and communication services appear to face significant both structural and cyclical challenges that currently undermine their appeal in investment portfolios.

By leveraging historical data alongside up-to-date sector metrics, investors can navigate low-growth scenarios with enhanced clarity and improve their risk-adjusted returns.