As markets tumbled under the threat of a trade war with China, Goldman Sachs told clients there would be one distinct group of winners and one group of losers in the stock market as this foreign policy drama unfolds.
"Services ﬁrms are less exposed to trade policy and have better corporate fundamentals than goods companies and should outperform even if the trade tensions are ultimately resolved, as our economists expect," wrote David Kostin, Goldman's chief U.S. equity strategist.
Stocks are getting hammered this week as President Donald Trump threatened new tariffs on China after the U.S. said Beijing reneged on key parts of a developing trade agreement. The Dow Jones Industrial Average is down nearly 540 points this week while the and the Nasdaq are down more than 2%. U.S. Trade Representative Robert Lighthizer said the U.S. is raising tariffs on $200 billion worth of Chinese goods from 10% to 25% on Friday.
This turmoil will divide the market into two parts, Goldman's strategy team said. They split the S&P 500 into two baskets: goods-producing companies and services-producing companies, evaluating each one's risk factors during a looming trade war.
"The trading pattern during the past year of tariff announcements and delays suggests services-providing stocks will outperform goods-producing stocks as long as the trade dispute continues," the note said.
Plus, these companies have more stable gross margins and stronger balance sheets, the firm points out, which could lead to their outperformance regardless.
On the other side, goods-producing companies like Apple, with $10.22 billion in sales in its greater China category for its second quarter, along with Johnson & Johnson and Exxon Mobil are more exposed to retaliation by China.
"Counter-intuitively, wage inﬂation above 3% will provide a slight relative boost to services ﬁrms, which commit a smaller share of revenues to labor," Kostin said.
Plus, Goldman noted that of the 260 companies in the services basket, 175 or 58% of market value, also fall into Goldman's domestic sector basket, less exposed to China. The goods basket is overwhelmingly international, 193 companies or 85% of market cap fall into Goldman's global sector basket.
Within the goods basket, companies like Procter & Gamble, Intel, Chevron, Coca-Cola and Boeing, are estimated to have negative earnings growth of 2% and no sales growth at all this year, the firm said.
"The faster growth rate supports the valuation premium of services, which trades at a 17.5x forward P/E multiple vs. 16.8x for goods," Kostin said in the note.
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