10 Stocks That Can Outperform in 2018: Goldman

Investors should reduce tech stocks to an equal weight allocation in their portfolios, while going overweight in financials and industrials, Goldman Sachs Group Inc. (GS) advises. This important pivoting of investment strategy was presented in their U.S. Weekly Kickstart report dated January 12. What Goldman calls its "Conviction List" contains 15 buy-rated stocks, including these 10, with their expected gains implied by the differences between their January 11 closes and Goldman's 2018 target prices:

• Bank of America Corp. (BAC), +8% to target price
• Wells Fargo & Co. (WFC), +10% to target price
• MetLife Inc. (MET), +14% to target price
• Intercontinental Exchange Inc. (ICE), +12% to target price
• BlackRock Inc. (BLK), +13% to target price
• Deere & Co. (DE), +27% to target price
• Caterpillar Inc. (CAT), +21% to target
• Northrop Grumman Corp. (NOC), +16% to target
• L3 Technologies Inc. (LLL), +9% to target
• United Parcel Service Inc. (UPS), +9% to target

To put these recommendations in perspective, Goldman is projecting a year-end value of 2,850 for the S&P 500 Index (SPX), just 2.7% above its January 16 close. (For more, see also: 5 Top Value Stocks for 2018.)

Financial Stocks

Goldman highlighted 10 financial stocks, of which five are included above. Tax reform, deregulation, and rising interest rates should be the major drivers of outperformance among large-cap banks such as Wells Fargo and Bank of America, in Goldman's view. With excess capital of 8% and 9%, respectively, per the latest CCAR bank stress tests performed by the Federal Reserve, Goldman's analysts expect these two banks to increase share repurchases by about 34% and dividends by about 19% through the 2019 CCAR year.

Bank of America should be an especially big beneficiary of rising interest rates, per Goldman, given its large book of floating rate loans and strong deposit franchise. Wells Fargo, meanwhile, should be putting regulatory issues behind it, in Goldman's opinion.

MetLife is on track to add between 100 and 150 basis points to its ROE by 2020, Goldman projects. Investments in cost saving technology and a less volatile business mix should drive the profitability improvement. Additionally, life insurance companies are among the biggest winners when the yield on the 10-Year U.S. Treasury Note rises, Goldman adds.

Industrial Stocks

"Machinery stocks present a particularly compelling opportunity in 2018 as the industry continues to emerge from a cycle trough," Goldman writes. Per their analysis, Deere and Caterpillar have strong operating leverage, while Deere has expanded its profit margins. Both also have "attractive normalized valuations" in Goldman's opinion.

Additionally, Caterpillar is starting to realize benefits from productivity-enhancing and cost-cutting investments, per Goldman. In that vein, Goldman also placed Deere in a basket of stocks that are expected to outperform as the result of high R&D investment and capital spending. (For more, see also: 9 Stocks That Can Outperform As Bull Market Ages: Goldman.)

"Defense stocks should outperform again in 2018 as growth continues to exceed expectations," Goldman says. In particular, they project higher 2018 revenue growth than consensus for Northrop Grumman (+7% vs. +6%) and L3 (+6% vs. -3%). Over the next decade, Goldman forecasts 10% average annual revenue growth for Northrop Grumman. Regarding L3, they find it valued less than its peers on the basis of P/E, EV/EBITDA, and FCF yield, discounts that they expect to shrink in 2018, propelling the stock higher.