Buy Amazon and Google, sell Apple and Exxon: Here's an in-depth look at Goldman Sachs' newly unveiled strategy for fighting the trade war
- As the US-China trade war escalates, Goldman Sachs has created a new strategy for investors looking to stay above the fray - and maybe make some money in the process.
- The focal point of Goldman's newly unveiled strategy is the division of the S&P 500 into two distinct groups: service providers and goods producers.
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When it comes to the US-China trade war, Goldman Sachs is drawing a line in the sand.
No, the firm is not picking a side. It's simply splitting the benchmark S&P 500 into two distinct groups - one containing companies that provide services, and another filled with goods-producing firms.
Based on Goldman's exhaustive analysis, the service providers look well-positioned to beat the market. As a result, loading up on exposure to the group looks like a prime way to weather trade-war-driven turbulence.
"Services firms are less exposed to trade policy and have better corporate fundamentals than Goods companies," David Kostin, Goldman's chief US equity strategist, wrote in a client note. "They should outperform even if the trade tensions are ultimately resolved, as our economists expect."
The chart below shows this dynamic in action. As you can see, negative trade-war developments have been followed by periods of sharp outperformance for service providers, relative to their good-producing counterparts.
But Goldman didn't stop there. In order to strengthen its argument in favor of service providers, it weighed the relative merits of five fundamental attributes, each of which is discussed below:
(1) More domestically focused sales
Goldman notes that its services basket got 80% of revenues from domestic sources in 2017, compared to just 55% for the goods group.
"Similarly, our Services basket has a large constituent overlap with companies in our Domestic sector basket," Kostin said.
(2) More favorable inflation outlook
Goldman argues that the current inflation outlook looks more kindly upon service provides, as opposed to producers of goods.
"Goods inflation will hover around 0%, offering little upside to 2019E sales growth of 0% for the Goods basket," Kostin said. "In contrast, Services inflation of 3% supports 9% sales growth for Services
firms."
Speaking of top-line expansion...
(3) Faster sales and earnings growth
Kostin points out that higher inflation generally implies higher sales growth. And stronger revenue expansion gives a company a higher likelihood of growing on the bottom line as well.
"During the past five years, the median Services firm generated average annual sales growth of nearly 7% compared with 4% for the median constituent in the Goods basket," he said.
(4) More stable margins
While Kostin notes that goods producers have seen higher average gross margins over the past five years, he's more interested in long-term stability. And by that criteria, service providers win out once again.
"The median Services company has had more stable gross margins during the past five years," he said.
(5) Stronger balance sheets
The last attribute is one that's been highlighted by many Wall Street strategists as the current cycle enters its final innings: balance sheet quality - otherwise characterized as "strength."
Kostin lays it out in simple terms: "Services companies have stronger balance sheets than Goods companies."
With all of that established, one big question remains: Which companies are housed in these two baskets? Here are the 10 largest weightings in each one, should you wish to seek single-stock exposure to Goldman's recommended strategy:
Service providers: Microsoft, Amazon, Alphabet, Facebook, Berkshire Hathaway, JPMorgan Chase, Visa, Bank of America, Cisco Systems, Verizon
Goods producers: Apple, Johnson & Johnson, Exxon Mobil, Procter & Gamble, Intel, Pfizer, Chevron, Merck, Boeing, Coca-Cola