As a market built on Trump rally optimism meets a legislative reality that might not be able to get much done, including any meaningful tax reform, where does one invest in a market environment which Goldman Sachs now categorizes as “Gridlock” in the subtitle of a “Where to Invest Now” report?
With median stock prices trading near 99th percentile, don’t worry about legislative accomplishment
With its legislative agenda “delayed” after a derailed attempt at healthcare reform, a tax policy that is now going back to the drawing board and even financial reform in jeopardy, Goldman notes that market bulls are turning their focus to corporate and economic fundamentals.
Even here, however, the numbers provide a mixed bag.
While corporate operating earnings per share are expected to rise 9% to an average of $116, the question is, with the S&P 500 index trading at an elevated valuation in the 89th percentile – and the median stock trading in the 99th percentile — just how much positivity is already priced into the market and how far can any rally go?
In such an environment, Goldman’s Global Investment Research team, headed by David J. Kostin, sifts through a cloudy landscape in an attempt to find the diamonds in the rough. The conclusion is corporations with high tax rates, low labor costs and stocks with secular growth potential.
Where to invest with legislative accomplishments in question
For Goldman Sachs, the path of the S&P 500 is going to be one of steady decline as the “hope led market” that rocketed the index to 2400 will give way to a 2300 print to close 2017. From this point, Goldman sees a 100-point rise in each of 2016 and 2019 as corporate EPS climbs to $122 and $129 respectively.
Tax beneficiaries have given up their strong gains, after Goldman's high tax rate basket of stocks rocketed from $99 to $103 just after election day, topping out near $104 and are now trading at $98, reflecting diminished hope for meaningful tax reform. Likewise, infrastructure stocks, which jumped after election day on hopes of massive Trump fiscal stimulus, have mostly given back all their gains and the “bank deregulation premium” has all but vanished as the markets move “from hope to reality.”
The moves come as net long positioning is approaching six-year highs and Goldman’s market sentiment indicator is elevated and the month of April typically is among the lowest months for stock buybacks to engineer a lift to the market.
Specific stock picks based on secular growth, tax beneficiaries
The April slide presentation notes that there is event risk in the form of the first round of French elections, a point of underlying market tension, and a continuing budget resolution in the US on April 28 potentially providing investors a headwind. But this is juxtaposed to positive economic surprises in the US, and strong sentiment across the board. This highlights an economy where “soft” data, such as sentiment surveys, exists alongside what Goldman calls “steady” hard economic numbers where economic activity remains positive. This all guides Goldman’s expectation for 2.2% economic growth and only two more interest rate hikes in 2017.
With 63% of the S&P 500’s returns since 2009 estimated to have been driven by earnings, economic numbers looking reasonably positive and 2017 net corporate profits estimated at near 8.5%, Kostin and his team look to areas in which to invest amid an unclear policy future.
One area is in stocks that already have low labor costs and secular growth stocks that trade at reasonable valuations. Among this list of “value” stocks, Goldman includes GrubHub and Amazon.com among a bevy of information technology stocks.
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