Goldman Sachs says get defensive for 2019 and buy 'high quality' stocks as recession fears rise

• "Investors should increase portfolio defensiveness given our forecast for heightened risk and fat tails," Goldman Sachs says.
• The firm has mixed confidence about next year's market.
• Goldman recommends investors own "high quality" stocks in 2019.

Michael Nagle | Bloomberg | Getty Images

A trader works on the floor of the New York Stock Exchange (NYSE) in New York, U.S., on Monday, Aug. 21, 2017.

Goldman Sachs has mixed confidence about next year's market and is warning investors to protect themselves with "high quality" stocks, as many clients are telling the firm that a U.S. economic recession is coming as soon as 2020.

"Investors should increase portfolio defensiveness given our forecast for heightened risk and fat tails," Goldman Sachs analyst David Kostin said in a note on Friday.

A fat tail is a way Wall Street describes a larger than usual amount of risk. Goldman Sachs expects the S&P 500 index will reach 3,000 by the end of next year, from about 2,600 this week. The firm assigns a 50 percent probability to that baseline scenario. But Goldman sees a 30 percent probability for its downside 2019 forecast of 2,500 and a 20 percent probability for its upside forecast of 3,400.

"The likelihood of tail events is not symmetrical," Kostin said. "The market path in 2019 will depend on investor perception of the longevity of the current economic expansion."

But investors do not sound optimistic. Kostin said that "scores" of Goldman Sachs' recent meetings with clients "indicate that many investors believe the US economy will enter a recession in 2020."

With that expectation, the firm recommends investors own "high quality" stocks with attributes such as strong balance sheets, high return on equity and consistent cash flow. Alphabet, PepsiCo and Mastercard are among the stocks in its high quality basket.

More broadly, Goldman also recommends investors favor utilities and communication services as these two defensive sectors "typically outperform in decelerating GDP growth environments," Kostin added.