Goldman says the sell-off is just about over and tells investors to get back into growth stocks

  • Goldman Sachs strategist David Kostin said there is "limited further downside" for stocks after the recent sell-off sent the Dow industrials down almost 6 percent.
  • Strong fundamentals, including rising earnings and return on equity, should limit the damage, he said.
  • Goldman continues to call for a 2,850 price target on the S&P 500, which would be about 3 percent higher from Friday's close.
  • Goldman is advising clients to shift to growth stocks with an emphasis on strong balance sheets.

While investors wait for the sequel to last week's market sell-off, Goldman Sachs strategists think the worst of it already may have passed.

As Wall Street recovered from a nearly 6 percent sell-off from the most recent high in the Dow industrials that knocked more than 1,500 points off the blue chip index, Goldman's experts said solid fundamentals should help keep a floor for stock prices.

"We see limited further downside," David Kostin, the firm's chief U.S. equity strategist, said in a note. He added that the kind of pullback the market saw last week was common. "Despite the recent sell-off, equity fundamentals are strong and we remain constructive on the path of the S&P 500," he added.

Goldman's year-end price target for the S&P 500 is 2,850, which looked somewhat pessimistic when the market was breaking records but now points to 3 percent upside from Friday's close, and, perhaps more importantly, conviction that the market drop doesn't have much further to go.

The sell-off came about amid myriad challenges, including indications from the Federal Reserve that more rate hikes are on the way than the market had anticipated. The tipping point for the market could have been remarks from central bank Chairman Jerome Powell, who said after the close Oct. 3 that the Fed was "a long way" from what it considers an interest rate neither restrictive nor stimulative.

Stocks started dropping the following day, and last week featured several volatile sessions and particularly sharp drops Oct. 11-12.

The Goldman call runs counter to much of the thinking on Wall Street at least over the near term. Multiple forecasters said last week that the immediate backdrop does not look friendly for stocks.

But Kostin said such declines are normal and shouldn't have longer-lasting effects. The S&P 500 historically has seen 5 percent drawdowns every 71 trading days, and it had been 69 since the last one.

Investors, though, have gotten used to a low-volatility environment that has persisted for most of the past two years and indeed since the bull market began in 2009.

Kostin acknowledged there are challenges.

Wages are increasing at a 3.3 percent rate, the highest since the recovery began in mid-2009, according to Goldman's tracker. In addition, the firm thinks there's a 60 percent chance that President Donald Trump levies tariffs on the remaining $267 billion worth of Chinese goods that haven't already been targeted.

However, rising earnings, which are expected to increase 19.1 percent for the third quarter from the same period a year ago, should assuage some of those concerns. Also, return on equity continues to climb, pointing to margin expansion.

In the face of those headwinds, Goldman is advising clients to shift to growth stocks with an emphasis on strong balance sheets. Those with lower debt levels will have a better ability to withstand rising interest rates.

Goldman's basket of growth stocks with the highest return on equity has modestly outperformed the S&P 500 this year, gaining 4.1 percent compared with the index's 3.5 percent. Apple, Microsoft, Nike and Deere are among the stocks in this basket.

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