Will This ETF Beat the Market Over the Next 12 Months?

2024 was another banner year for the US stock market, with the S&P 500 notching a gain of 23%. Dwarfing even this return, though, was that of the Financial Select Sector SPDR ETF (XLF), which has delivered a 29.7% return over the last 12 months.

There is lots of speculation that the new President will be supportive of the financial sector so can XLF beat the market again in 2025, and what risks does this high-performing ETF have compared to the market as a whole?

A Quick Look at XLF

XLF is a relatively concentrated fund made up of large, dominant financial companies. The fund’s top three holdings are Berkshire Hathaway, JPMorgan Chase and Visa.

These three stocks account for roughly 30% of the fund’s assets, though XLF does include 73 individual stocks in total.

The fund charges a 0.09 percent expense ratio and currently yields 1.3 percent in dividends.

How Is the S&P 500 Expected to Perform in 2025?

To determine whether XLF has a good chance of beating the S&P in 2025, we first have to establish some basic expectations for how America’s benchmark index could perform this year. Goldman Sachs projects a roughly 10% return for the index over the coming year.

Earnings growth, however, is forecasted to come in at 14.8%. Given the fact that the S&P trades at a fairly high multiple to earnings already, there could be some compression in 2025. As such, the 10% Goldman Sachs figure seems to be a reasonable, conservative estimate to measure other assets against.

Why XLF Could Outperform in 2025

One of the first and most obvious reasons that an ETF composed entirely of financial companies could beat the S&P this year is that the Federal Reserve’s plan for interest rate cuts in 2025 is much more modest than initially assumed. As of now, the Fed is only planning on two rate cuts this year. As a result, banks and other financial institutions are likely to continue generating higher earnings from interest income.

Financial companies could also continue to prosper if American consumer spending remains strong. Though household debt has risen significantly since its retreat during the COVID-19 pandemic, the combination of rising wages and a strong job market has left American households in a decent position to manage their debts and continue spending.

Another very strong argument in XLF’s favor is that financial stocks don’t carry the very high valuations that have become common among tech stocks. As of the end of last year, the Magnificent Seven tech stocks made up almost 35% of the S&P 500’s total market capitalization.

While the surge of these mega-cap companies has helped the S&P deliver two consecutive years of returns above 20%, it has also driven the index’s trailing P/E ratio to 29.4. XLF, by contrast, carries a P/E ratio of just 17.1.

So far, we’ve looked at the points in XLF’s favor. However, it’s also important to consider how they compare to the S&P.

Beginning with interest rates, the same higher rate environment that can be so beneficial to financial stocks weighs on high-growth tech stocks like the Magnificent Seven. As such, the Fed’s dovish approach to bringing down interest rates could slightly hamper the performance of a generally tech-heavy market while giving support to the financial sector.

Furthermore, there are increasing worries on Wall Street that the current tech boom is approaching its logical limits. Since AI stocks started to surge two years ago, their rising valuations have been compared to the dot-com bubble of the 1990s. Though this criticism hasn’t stopped the market’s rise, there’s still a decent chance that highly-valued tech stocks could correct in 2025 as the market prices in more realistic expectations for AI.

What Are the Risks?

Although a lower valuation could help XLF beat the S&P 500, the financial sector is unlikely to be insulated from a general stock market correction if one takes place. While they may fare better than the priciest tech stocks, there’s little reason to believe that the stocks contained in XLF will remain buoyant if the stock market in general trends downward.

Another major unknown in 2025’s outlook is whether the incoming Trump administration will put large new tariffs on goods coming to the United States from abroad.

Although financial companies wouldn’t be directly impacted by this, they would see the effects of a market downturn in the form of less demand for loans.

The Tax Foundation estimates that a 10% universal tariff would result in a 0.5 percent reduction in real GDP. Other estimates are even grimmer, with Moody’s forecasting a 3.6% hit to real GDP by 2028.

Higher tariffs would also squeeze consumer budgets, straining the strong consumer spending that financial companies are banking on to keep demand for capital high. Estimates suggest that the average household would see costs rise by about $2,600 as a result of tariffs getting passed along to consumers.

This is money that won’t be spent on new homes, automobiles or other major purchases. The increased costs could also cause consumers to lose confidence and pull back in other areas, weakening the overall macroeconomic outlook.

So, Will XLF Beat the Market Again This Year?

There’s a strong argument that XLF will deliver another year of market-beating returns in 2025 as a result of favorable regulatory policies from the new administration.

While there are risks on the horizon, they’re mostly macroeconomic risks that are shared by all US companies to some degree. The interest rate tailwinds working in favor of the financial sector, though, could work against some of the largest tech companies in the S&P 500.

It’s also worth considering that the stocks in XLF may be slightly more resistant to an unexpected market downturn than the high-flying S&P 500 at large. Because they trade at lower multiples, financial stocks may not have as far to fall if a correction takes place this year.

Financial companies that don’t have massive technological advances priced in may also rebound faster after a correction, leaving them potentially exposed to less volatility risk than the increasingly tech-heavy S&P.

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The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.