How Goldman strategist plays the improving economy

Kostin: Cyclicals & lower valuation good strategy for environment
Kostin: Cyclicals & lower valuation good strategy for environment   

Goldman Sachs sees the U.S. economy gathering steam later this year following a sluggish first quarter, and investors have an opportunity to increase their exposure to the upside, the investment bank's chief U.S. equity strategist said Tuesday.

"As earnings move slowly higher, the market should generally rise in that direction," David Kostin said on CNBC's "Squawk on the Street." "So from a strategy perspective, we look more for cyclicals, and lower valuations would be a good strategy in this environment."

Market watchers expected the economy to be growing sharply and strongly at beginning of the year, but economic activity instead decelerated for several reasons, Kostin said. As a result, defensive stocks outperformed, trading 19 times forward earnings, he said.

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Investors can buy cyclicals at 16 times forward earnings and get better exposure to an improving economy if indeed GDP growth does pick up this year, he said.

"From an economic perspective, the U.S. is showing signs of improvement, from the housing point of view, from consumer, the labor market. All of those would suggest the economy is getting better, which would suggest, again, strategically, you want to be in more cyclicals and lower valuation stocks."

Goldman Sachs is bullish on automotive and airline stocks, as well as the tech sector, Kostin said.

The firm anticipates marginal growth in U.S. markets this year. It forecasts the S&P 500 will end the year at about 2,100. Its 52-week high is 2,152.

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U.S. indexes will likely experience pressure following the Federal Reserve's anticipated interest rate hike, said Kostin, who noted price-to-earnings multiples have historically compressed about 8 percent following past central bank tightenings. A stock's price-to-earnings ratio is a measure of its expected future earnings growth.

"Then ultimately it will be a function of whether the economy is improving," Kostin said. "Is the economy improving as we anticipate? Then earnings can go a little higher in 2016."