Stick With Quality Stocks in This Downturn: Strategists

Goldman Sachs strategists led by David Kostin, chief U.S. equity strategist, are less bearish for now but acknowledge the selloff in the S&P 500 marks “a difficult start to the new year for equity investors” and is “particularly challenging for fund managers to navigate.”

Goldman strategists are not abandoning their base case for the S&P to end the year near 5,100, which is supported by an 8% rise in earnings per share. They acknowledge, however, that if corporate profits fall and the consensus EPS forecast for the S&P 500 declines from $224 in 2022 while real yields remain unchanged and the gap between real and nominal Treasury yields are unchanged, the implied value of the index could drop to around 3,914.

“Stocks are getting hit by this for two reasons,” writes Jacob Manoukian, U.S. head of investment strategy at J.P. Morgan Private Bank, in a recent note. “The rate at which investors discount future cash flows is higher, which brings down the current valuation of companies … [and] higher rates usually mean slower economic and earnings growth in the future, which can hurt stock prices now.”

Manoukian notes, however, that stocks “tend to find their footing once they adjust to higher policy rates,” noting the S&P 500 returned an average of 13% in the last six hiking cycles, which lasted 18 months on average. “Equities tend to rally during rate hiking cycles because they tend to happen when the economy is strong. We don’t see a compelling reason why this time would be different.”

Despite these varying views of the current stock market, the strategists all recommend that investors now focus on high-quality stocks.

For Goldman strategists, that means investing in companies that are highly profitable, with strong balance sheets and modest valuations. Goldman is overweight health care stocks.

At J.P. Morgan, Manoukian writes: “Focusing on profitability should be increasingly valuable as interest rates continue to rise.”