A long-overdue correction of 10% to 20% in U.S. stock prices is likely during the next few months, according to strategists at Goldman Sachs Group Inc. (GS), as reported by CNBC. However, rather than a reason to flee stocks, Goldman sees a major pullback as a buying opportunity in anticipation of further gains, per Bloomberg.
"We remain overweight [in equities] and think that bear market risks are low," Goldman's chief equity strategist, Peter Oppenheimer, said in a Monday research note as quoted by CNBC. He added, "It is typically better to buy a market when the news is poor and valuations are low than when all news is good and valuations are high."
The total value added to U.S. equities during January is on track to set a new all-time monthly record, Bloomberg calculates. Meanwhile, optimism about economic growth and corporate profits is at peak levels worldwide as reflected in the MSCI All-Country World Index, which is near a record high, Bloomberg adds. However, from their record closing values on Friday January 26, the S&P 500 Index (SPX) and the Dow Jones Industrial Average (DJIA) have fallen by 1.4% and 1.6%, respectively, through 11:00 AM New York time on January 30.
"Rising valuations, amid increased optimism, make the market more vulnerable to a setback even if the underlying trend remains intact," Bloomberg quotes from the Goldman report. Among the warning signs that Goldman sees right now are, per Bloomberg: their gauge of investors' appetite for risk is near record highs; they see widespread complacency about political risks, such as upcoming elections in Italy; and the CBOE Volatility Index (VIX) has been rising, which may be signaling increased fear among investors, per CNBC. However, CNBC adds, Goldman's report suggests a possible alternative interpretation about the rising VIX: "a bullish willingness to spend premium to add to upside exposure."
Another sign, per Goldman as cited by CNBC: the S&P 500 is in its longest upward period since 1929, the year of the Great Stock Market Crash, without a correction of at least 5%. Nonetheless, Goldman adds that the average correction in a bull market lasts four months, sends stock prices down by 13%, and the subsequent recovery takes only another four months.
Goldman has specified key categories of stocks where it sees the best buying opportunities. As far as sector allocations, Goldman recommends that investors go overweight in financials and industrials, according to their January 26 report, "Where to Invest Now--Year 2." Goldman also reiterates three long-running investment themes of theirs that they believe will lead to outperformance: firms that invest for the future, with high ratios of capital expenditures and R&D spending to cash flow from operations; secular growth stocks, with revenues rising at average annual rates in excess of 10%; and M&A targets in industries with low market concentration, and thus high likelihood that regulators with approve takeovers. (For more, see also: 8 Stocks Poised to Gain on Takeovers in 2018.)
In this report, Goldman identifies 27 stocks that meet at least two of the five investment themes mentioned above. Among them are, with the themes that each fits into, along with the implied gains from their closing values on January 19 to Goldman's target prices:
- E*TRADE Financial (ETFC): financials, M&A, +23% to target price
- Comerica Inc. (CMA): financials, M&A, +10% to target price
- L3 Technologies Inc. (LLL): industrials, M&A, +10% to target price
- TransDigm Group Inc. (TDG): industrials, M&A, +32% to target price
- Deere & Co. (DE): industrials, investing for the future, +27% to target price
- Amazon.com Inc. (AMZN): secular growth, investing for the future, +12% to target price
- Kimberly-Clark Corp. (KMB): investing for the future, M&A, +22% to target price
All seven stocks listed above also have buy ratings from Goldman. Note that there are several anomalies among the 27 stocks on the full list: only 12 have buy ratings; the six stocks with the highest expected returns to their target prices (19% or more) include two with neutral ratings; one stock is rated a buy, but its target price represents a loss; and the lone stock that meets three themes is rated neutral and is expected to be flat in 2018. Recently, Investopedia offered more detail on Goldman's secular growth picks. (For more, see also: 4 Reasons the Stock Market's Future Is Bright: Goldman.)