Even as the S&P 500 Index (SPX) hovers near its all-time high, a recent report from Goldman Sachs finds that stocks in three areas still have significant potential for additional gains: services-providing companies, dividend-paying stocks, and domestic-focused firms. Among the 50 stocks in Goldman's basket of stocks with a high percentage of sales derived within the U.S. are: Anthem Inc. (ANTM), AllState Corp. (ALL), Charter Communications Inc. (CHTR), Norfolk Southern Corp. (NSC), Republic Services Inc. (RSG), and Arista Networks Inc. (ANET).

Additionally, Goldman also recommends that investors focus on aerospace and defense stocks with the lowest exposure to China. They note that these have the lowest reported sales to the Asia Pacific region, the closest proxy they can find across most company reports for sales to China: Northrop Grumman Corp. (NOC), TransDigm Group Inc. (TDG), and Huntington Ingalls Industries (HII).

Significance for Investors

"Our economists expect that a U.S. recession is unlikely during the next two years," Goldman says in a recent edition of their U.S. Weekly Kickstart report. "They highlight the lack of economic imbalances and believe that elevated consumer spending and a smaller drag from inventory accumulation should boost economic growth through the end of 2019 and 2020," the report adds.

"During the past 10 years, Aerospace & Defense has been least sensitive to U.S. and global economic growth across Industrials subsectors," the report observes. "High defense spending should continue to boost the top-line of Aerospace & Defense companies," it adds. Moreover, Goldman's recommendation of these stocks is bolstered by this finding: "Outside of recessions, Aerospace & Defense has outpaced the S&P 500 by a median of 250 bp during the 6-month period when the ISM [Manufacturing Index] fell from 50 to its trough." The ISM recently dipped below 50.

Analyst Rajeev Lalwani at Morgan Stanley has an overweight, or buy, rating on Northrop Grumman, per Barron's. His price target is $418, or 12.5% above the close on Sept. 16. Shares of Grumman have risen about 9% since Lalwani's report was released. He projects accelerating growth in the company's profit margins and sales, leading to positive earning surprises. “Northrop is the best way to play the long-term strategic priorities of the U.S. government,” he wrote in a report, as quoted by Barron's.

Meanwhile, investing in stocks with high sales exposure to the U.S. market is a way to hedge against a continued worsening of the U.S.-China trade conflict. Goldman indicates that the median stock in the S&P 500 derives 71% of sales in the U.S., while the median stock in its domestic sales basket gets 100%. Of the six stocks from this basket highlighted above, Arista has 72% U.S. sales and all the others are at 100%.

Looking Ahead

An ISM Manufacturing Index reading below 50 normally indicates that the U.S. manufacturing sector is contracting. However, Goldman believes that manufacturing is stabilizing, and expects that continued U.S. economic expansion will support the sector, thus they remain overweight in industrials.

Moreover, Goldman finds that the ISM index has been a poor predictor of upcoming recessions, given that, since the 1990s, recessions have followed an ISM reading below 50 only 30% of the time. Much of the reason for the diminished value of the ISM index as an economic leading indicator comes from the fact that manufacturing is now only 10% of U.S. GDP, down from 20% in the 1970s and 1980s.