Goldman sees more volatility, says buy these stocks with the best potential risk-adjusted returns

Published Mon, Jun 29 20209:29 AM EDT

(This story is for CNBC Pro subscribers only.) The coronavirus pandemic, which appears to be seeing a resurgence, is causing more market turbulence with the S & P 500 about to snap a two-month winning streak. Goldman Sachs is warning clients of more wild swings ahead and giving them a strategy to do something about it. "High volatility and low risk-adjusted returns likely to linger, complicating the outlook for performance," David Kostin, Goldman's chief U.S. equity strategist, said in a note. "Consensus expects 9% upside to the typical stock over the next 12 months and volatility should remain elevated through the rest of the year, suggesting low risk-adjusted returns in the coming months." The bank believes investors should look at stocks with a high level of Sharpe ratio, which Kostin said will deliver the best risk-adjusted returns going forward. The so-called Sharpe ratio is a measure of a stock's performance relative to its volatility. Goldman uses consensus price targets and options six-month implied volatility to measure Sharpe ratios. Goldman's high Sharpe ratio basket consists of 50 S & P 500 stocks with the highest prospective Sharpe ratios. It has a long track record of beating the market — the basket has outperformed the S & P 500 in 66% of semi-annual periods since 1999 by an average of 271 basis points, the bank said. However, the basket has underperformed the S & P 500 so far this year partially because it has a tilt towards value names which have experienced substantial price declines, Kostin said. "Laggards and low valuation stocks often screen into the High Sharpe Ratio basket because of their expected upside to analyst price targets," Kostin said. In May and early June, however, the basket outperformed the market as economic data improved and value stocks rallied, Kostin added. The median stock in the basket has an expected return of 24% based on the 12-month price targets, and the basket trades at a 31% discount on forward P/E, according to Goldman. Goldman's high Sharpe ratio basket includes a couple of retail names and casinos, which had been among the hardest-hit industries amid the pandemic. Ulta Beauty, Las Vegas Sands and Ross Stores have all lost more than 20% this year as the coronavirus caused temporary closures. Chipmakers Western Digital , Micron Technology and Applied Materials also made the list. Semiconductor stocks have shown resilience this year as Wall Street largely remained bullish on the adoption of 5G and the secular growth in the industry. The basket also includes health care players Cigna and Merck & Co. , as well as financials Citigroup and Hartford Financial . — CNBC's Michael Bloom contributed reporting.

People are walking by the New York Stock Exchange (NYSE) building during Covid-19 pandemic in New York on May 26, 2020.

Tayfun Coskun | Anadolu Agency | Getty Images

(This story is for CNBC Pro subscribers only.)

The coronavirus pandemic, which appears to be seeing a resurgence, is causing more market turbulence with the S&P 500 about to snap a two-month winning streak. Goldman Sachs is warning clients of more wild swings ahead and giving them a strategy to do something about it.

"High volatility and low risk-adjusted returns likely to linger, complicating the outlook for performance," David Kostin, Goldman's chief U.S. equity strategist, said in a note. "Consensus expects 9% upside to the typical stock over the next 12 months and volatility should remain elevated through the rest of the year, suggesting low risk-adjusted returns in the coming months."

The bank believes investors should look at stocks with a high level of Sharpe ratio, which Kostin said will deliver the best risk-adjusted returns going forward.

The so-called Sharpe ratio is a measure of a stock's performance relative to its volatility. Goldman uses consensus price targets and options six-month implied volatility to measure Sharpe ratios.