- The economy’s reopening is likely to be an uncertain and unequal process, says David Kostin, the chief equity strategist of Goldman Sachs.
- He recommends an investing strategy that simultaneously captures the upside of recovery and hedges the downside of the unfolding recession.
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The White House last week announced a phased approach that states can use to reopen businesses like gyms and bars, provided that new coronavirus cases are on a downward trajectory.
States including Georgia and Florida have started lifting the strictest measures that froze swaths of their economies.
This process of pulling the broader economy out of its worst downturn in nearly a century is likely to be uncertain and uneven, according to Goldman Sachs. The investing implication, the bank added, is there is no one-size-fits-all strategy for investing in companies that will benefit as the economy returns to some form of normal.
For this reason, Goldman chief US equity strategist David Kostin advises a so-called barbell strategy that captures the upside of recovery and hedges the downside of the unfolding recession. One side of the strategy is exposed to cyclical stocks that rebound the fastest alongside the economy. The other side involves defensive stocks that will be relatively insulated from shrinking profits and corporate defaults.
In a recent note to clients, Kostin expanded this barbell strategy into three plans of action, and named four companies that have broad exposure to them. His recommendations are as follows:
1. Avoid small-business exposure
Smaller businesses are at greater risk of defaulting on their debt and seeing their profit margins shrink, Kostin said.
And it’s not just the companies themselves at risk: a Goldman Sachs basket of firms that earn the highest share of revenues from small and medium-sized business has lagged the S&P 500 year-to-date. Kostin seems more downside to such names as the pressures on small businesses mount.
2. Buy quality stocks at a reasonable price
Kostin recommends companies with strong balance sheets because they are in a great financial position to weather the downturn.
The advantage of such companies is widely known and has caused them to outperform firms with weaker balance sheets this year. For this reason, many quality companies are trading at “extreme valuations”: the median stock in Goldman’s representative basket is trading at 25 times its 2021 earnings-per-share estimate versus 15x for the S&P 500 and 10x for the median non-quality stock.
That’s where the “reasonable price” part of the recommendation comes into play. Kostin identified stocks that rank in the top 20% of balance sheet strength within their sector, but are neither in the top nor bottom quintiles of valuations.
3. Buy-goods producing cyclical stocks
If China’s experience is any guide, goods-producing industries will reopen and recover faster than services. Kostin expects the same to happen in the US, particularly for manufacturers that sell directly to other businesses versus those that serve consumers and rely on in-person interaction.
Additionally, goods-producing stocks that benefit from an upswing in the economic cycle are better for the growth phase than their defensive counterparts. Kostin noted that Goldman’s basket of cyclical stocks has outperformed its defensives collection by 240 basis points during the three months after eight bear markets since 1980.
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