Financials and Cyclicals: Navigating Volatility for Long-Term Gains

The global economy is navigating a precarious balancing act in mid-2025. Trade tensions, fluctuating interest rates, and the lingering uncertainty of post-pandemic policies have investors seeking stability. In this environment, sector rotation strategies—shifting allocations toward industries poised to thrive amid volatility—are critical. While cyclicals (e.g., industrials, materials) remain tied to the whims of the economic cycle, the Financials sector stands out for its diversified sub-sectors that deliver resilience across market conditions. Payments, alternative assets (notably infrastructure), and market infrastructure are key drivers of this outperformance. Let's dissect why investors should prioritize Financials now and how to position portfolios for both near-term risks and long-term gains.

The Case for Financials: Diversification as a Shield Against Volatility

The Financials sector has been a standout performer since late 2024, with the S&P 500 Financial Sector Index rising over 30% in 2024, outpacing the broader market. This momentum is rooted in its sub-sector diversity, which insulates it from macroeconomic headwinds:

1. Payments: The Engine of Transactional Resilience

Payment processors like Mastercard (MA) and Corpay benefit from two structural tailwinds:
- Resilient Consumer Spending: Even in downturns, everyday transactions remain steady, shielding payments firms from broad economic slowdowns.
- Cross-Border Activity: The rise of global e-commerce and travel post-pandemic has boosted demand for cross-border payment solutions.

Investment Takeaway: Payments stocks are “defensive growth” plays. Allocate to leaders with global scale and exposure to emerging markets.

2. Alternative Assets: Infrastructure's Silent Growth Machine

Infrastructure investments—ports, data centers, renewable energy—are a cornerstone of the Financials-linked alternative assets sub-sector. Despite a 15% drop in fundraising in 2024, capital deployment surged 18%, driven by long-term demand for energy transition and AI-driven power needs.

• Energy Transition: The $6.5 trillion annual clean energy infrastructure pipeline by 2050 ensures steady demand for wind, solar, and grid modernization projects.
• Data Centers: AI's hunger for computing power is fueling a boom in high-quality data center assets. Returns here hit 11.2% in 2024, with demand for facilities near tech hubs (e.g., Northern Virginia) soaring.

Investment Takeaway: Focus on infrastructure funds with expertise in digital infrastructure and green energy. Publicly traded names like Brookfield Infrastructure Partners (BIP) offer exposure without the illiquidity of private deals.

3. Market Infrastructure: The Unseen Pillar of Financial Stability

Market infrastructure firms—operators of payment systems, clearinghouses, and exchanges—are the backbone of global finance. Their essential services (e.g., SWIFT, NYSE) ensure smooth transactions even in crises.

• Regulatory Tailwinds: Post-election U.S. policy shifts have reduced regulatory aggression toward banks, easing compliance costs.
• Interest Rate Dynamics: While falling rates compress bank margins, they also boost economic activity, benefiting transaction volumes.

Investment Takeaway: Overweight diversified banks like Wells Fargo (WFC) and M&T Bank (MTB), which combine traditional lending with robust capital positions.

Cyclicals: Opportunities, But with Strings Attached

Cyclical sectors like Industrials and Energy are also beneficiaries of the current growth environment but face sharper risks:

• Industrials: Tariffs on steel and aluminum remain a drag on margins, and supply chain bottlenecks persist.
• Energy: While oil demand is rising, geopolitical risks (e.g., Middle East tensions) and regulatory shifts toward renewables introduce volatility.

The Schwab Sector Views assigns a Marketperform rating to all sectors, but Financials' sub-sector resilience gives it an edge.

Sector Rotation Strategy: How to Play This

1. Overweight Financials: Allocate 25-30% of equity portfolios to Financials, with a focus on payments, infrastructure-linked firms, and well-capitalized banks.
2. Underweight Pure Cyclicals: Reduce exposure to industrials and materials unless clarity emerges on trade policies.
3. Use Data Centers as a “Buy the Dip” Opportunity: Their defensive cash flows make them ideal for volatility-driven dips.

Final Thoughts: The Resilience Edge

The Financials sector's sub-sector diversity acts as both a shield and a catalyst. Payments, infrastructure, and market infrastructure are not just surviving—they're thriving—amid macro uncertainty. While cyclicals may rebound during a “soft landing,” their volatility makes them riskier bets without policy clarity. For long-term investors, the Financials sector offers a balanced portfolio of growth and stability, ideal for navigating 2025's choppy waters.

Stay agile, focus on sub-sector leadership, and let the Financials sector's resilience work for you.