Investors need to prepare for a climate where the economy could snap back significantly in the second half, according to a Goldman Sachs analysis that sees a case for a cyclical stock rebound.
But along with the better-than-expected growth, the market also will have to contend with heightened political risk and global policy uncertainty that could trigger some volatility. Goldman also expects the Federal Reserve to cut interest rates, but probably not by as much as Wall Street expects.
"With the S&P 500 trading close to fair value, we believe investors should focus below the surface of the market for relative value opportunities," Goldman strategist Ben Snider said in a report for clients. He added that "investment decisions will rely on the expectation of macro changes on the investment horizon or relative value opportunities at a more 'micro' level."
Specifically, Goldman recommended cyclical sectors like financials and industrials, with an emphasis on transportation companies.
The recommendations also include a preference for "bond proxies" that have stable cash flows and high dividends including real estate, which has the third-highest dividend yield on the S&P 500 at 3.01%. Utilities also carry a high dividend yield at 3.17%, according to FactSet, but Goldman has cut its recommendation on the sector from neutral to underweight. Utilities has been a laggard all year, returning 12.9% vs. the S&P 500's 20%.
Goldman's second-half call runs counter to some of the other wisdom on Wall Street, where fears of a looming recession have generated some endorsements to get more defensive.
While economic growth slogged through the second quarter at what the Atlanta Fed projects to be a 1.3% pace, Goldman sees a shift in the economic data recently that will see growth rebound to around 2%.
One of the principal reasons for the resurgence will be lower interest rates. Goldman sees the Fed coming through with two cuts this year, though it considers market pricing of three quarter-point easings to be "unrealistic."
"Easy monetary policy is one reason US economic growth will likely accelerate in coming quarters," Snider wrote. "The inventory cycle represents another argument for US growth rebound, while the weight of policy uncertainty on business confidence is a downside risk."
One policy uncertainty area is health care, where both Democrats and Republicans have vowed to lower drug prices. Goldman recommends underweighting the sector while buying health care providers over pharmaceuticals
"Be wary of stocks in industries that will likely feature in campaign proposals and industries with high exposure to US-China trade," Snider wrote.