The S&P 500 (^GSPC -0.08%) rose 23.3% in 2024, marking the first time the index posted back-to-back years of 20% gains or higher since the 1990s.
There are 11 stock market sectors, but only three beat the S&P 500 last year: communications, financials, and consumer discretionary. Even the technology sector underperformed the S&P 500 last year. In fact, only 148 S&P 500 components beat the index last year, meaning over 70% of components underperformed the index.
Here's why these three standout sectors did well last year, how they can carry the momentum forward this year, and low-cost exchange-traded funds (ETFs) you can use to invest in each sector.
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The gold goes to...
Communications was the best-performing sector last year, producing a 34.8% total return (capital gains plus dividends). The sector was led by its three highest-weighted components: Alphabet (GOOG -0.41%) (GOOGL -0.51%), Meta Platforms (META -1.33%), and Netflix (NFLX 0.14%), which rose 35.5%, 65.4%, and 83.1%, respectively, in 2024.
Besides social media and streaming companies, the sector has traditional media giants like Comcast and Walt Disney, telecom companies, and more. Despite running up in 2023 and 2024, the sector remains a good value going into 2025.
Legacy media companies and telecom titans tend to pay dividends and feature inexpensive valuations. Even Alphabet and Meta have reasonable valuations because they generate tons of free cash flow and solid earnings growth.
The sector depends heavily on advertising and consumer spending. So a downturn in those categories could result in slowing growth and even a sectorwide sell-off. But the long-term outlook for the sector is encouraging, especially given Meta's success with monetizing Instagram and Netflix's expanding margins and pricing power.
Vanguard offers low-cost sector-based ETFs with 0.1% expense ratios. The Vanguard Communications ETF (VOX -0.83%) mirrors the sector's performance, making it a simple yet effective tool for investing in stocks like Alphabet and Meta.
The financial sector remains a balanced choice for value-focused investors
The financial sector was a standout winner in 2024. The sector includes Berkshire Hathaway; big banks like JPMorgan Chase and Bank of America; investment banks like Goldman Sachs and Morgan Stanley; regional banks; payment processors like Visa, Mastercard, and American Express, insurance companies, and more.
The sector has done well amid relatively higher interest rates. Banks can see expanded net interest margins during periods of higher rates because the difference between the rates they collect on lending (like mortgages and car loans) and what they pay on deposits and savings accounts widens. But higher interest rates can also slow economic growth.
Last year stood out because economic growth was solid despite higher rates. Integrated banks and investment banks thrived, with many of those companies seeing record profits and stock prices.
Payment processors like Visa had slowing growth but were remarkably resilient thanks to network effects that led to moderate earnings growth despite pressured consumer spending.
The financials sector has run up a considerable amount, so it isn't as compelling a value as it used to be. But relative to the S&P 500, it is still a decent value. The Vanguard Financials ETF (VFH -0.28%) features a 17.1 price-to-earnings ratio (P/E) and a 1.6% dividend yield, compared to a 27.1 P/E and a 1.2% yield for the Vanguard S&P 500 ETF (VOO -0.11%).
Economic slowdowns can affect the sector, making it cyclical. So investors should be aware of the potential volatility before diving headfirst into the Vanguard Financials ETF.
The consumer discretionary sector finished strong
The consumer discretionary sector had a slow start to the year, but a second-half rally by Tesla (TSLA -0.04%) and a new record high for Amazon (AMZN -0.23%) helped pole-vault it to a 26.6% total return in 2024.
It contains industries you may have thought were in a different sector. For example, carmakers like Tesla and legacy automakers fall under the consumer discretionary sector, although there's a case to be made that Tesla is more of a technology company and automakers like Ford Motor Company and General Motors are industrial. Similarly, Amazon and MercadoLibre are tech-focused companies in the consumer discretionary sector.
The sector holds many familiar names, like McDonald's, Starbucks, and Nike. Like the other sector ETFs on this list, the Vanguard Consumer Discretionary ETF (VCR -0.15%) is fairly top-heavy, with a combined 45.7% weighting in Amazon, Tesla, Home Depot, and Lowe's Companies. Beyond that, the fund achieves solid diversification with 298 components.
It can be highly cyclical. Slowdowns in consumer spending can affect home improvement budgets and lead to pullbacks on categories like expensive vacations or dining out. Run-ups in Amazon and Telsa have made the sector more expensive, with a P/E ratio around the S&P 500 average and a yield of just 0.7%. But it can continue producing market-beating gains if the economy grows reasonably and consumers open up their pocketbooks on discretionary goods and services.
The right way to approach sector ETFs
The communications, financials, and consumer discretionary sectors include completely different industries. But all three sectors can be cyclical and vulnerable to ebbs and flows in the business cycle.
By knowing the leading components in each sector, you can know what to expect from each one based on how different companies perform. For example, it would be very challenging for the communications sector to beat the S&P 500 if there were a major sell-off in Alphabet and Meta. Similarly, Amazon and Tesla could drag down the consumer discretionary sector even if the rest of it does well.
It's a bad idea to invest in any sector or ETF if you're trying to time the market. Betting big on a theme or idea just to make a quick buck is a great way to lose your shirt.
However, if you like a sector's top holdings for their long-term potential, buying a low-cost ETF can be a great way to achieve diversification.
