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Stocks that have gotten clobbered during the volatile 2018 cycle are the ones most likely to lead the market next year, according to Goldman Sachs.
The group specifically contains companies that will have the highest rate of return compared with their risk. Such stocks have badly underperformed the market this year, but Goldman's strategists say history has shown that this group will take the lead in what is likely expected to be a market with muted returns in 2019.
"Looking into 2019, we expect a continued environment of low risk-adjusted US equity returns," David Kostin, the bank's chief U.S. equity strategist, said in a note to clients. The firm sees "a combination of modest absolute returns to the S&P 500 and elevated risk."
Investors should be looking for "companies best-positioned to withstand late-cycle pressures," he added.
That includes companies with strong balance sheets, stable sales and good after-tax earnings. Energy and financials, two underperformers in 2018, are in position to post the best risk-adjusted returns next year.
Kostin specifically focused on companies that have high "Sharpe ratios," a measure that gauges a stock's return against its risk. A basket Goldman put together has seen a 19 percent median loss in 2018 that history has shown will reverse. The strategy has topped the S&P 500 return 68 percent of the time over six-month periods since 1999, with an average excess return of 3.1 percentage points.
Broadly speaking, Goldman has a 3,000 price target on the S&P 500 for the end of 2019. While the firm considers that a "low" return, it actually implies a nearly 14 percent return from Friday's close. However, it indicates just 5.3 percent upside from the firm's 2,850 target for the end of 2018.
Kostin said the market currently is below levels consistent with "a more substantial slowdown in growth than we expect." The firm sees GDP expanding at a 2.5 percent pace in 2019 and corporate earnings rising 6 percent.
Utilities and health care are also likely to benefit from the environment ahead, he said.