Goldman sees troubling market trend below the surface, recommends high-margin stocks

Published Mon, Dec 13 202111:32 AM ESTUpdated Mon, Dec 13 20213:36 PM EST

Though the S & P 500 has roared in the last year, just five stocks are responsible for a large portion of the broad-market index's return as of late – a worrisome trend for investors, according to Goldman Sachs. Apple , Microsoft , Nvidia , Tesla and Alphabet have contributed 51% of the S & P 500's returns since April 2021 and more than a third of its roughly 25% year-to-date gain, a team of Goldman's strategists led by David Kostin found. Market breadth — a measurement of the number of underlying stocks in an index that are participating in a big move — in the S & P 500 — has narrowed substantially between April and October, the strategists said. It's only been this narrow over a six-month period 11 times, going back to 1980, the firm found. In most of those cases, the broad-market index generated a below-average return over the next one, three, six and 12 months, and it experienced sharper drawdowns in the months following, according to Goldman. Typically when this happens, the trend continues for another four months while momentum "leaders" — stocks like Apple, Microsoft, Nvidia, Tesla and Alphabet — outperform. "Following market breadth declines of the recent magnitude, it has historically taken four additional months before a sustained increase in breadth takes hold and market leadership flips towards the previous laggards," Kostin said. "Record index concentration is both a cause and a symptom of a narrow market," he noted. "The market-cap weight of the 10 largest stocks in the index has increased for each of the past seven years and now registers at 31%, the highest level since at least 1980." Choosing high-margin names Goldman recommended investors look to stocks with high margins, which signal quality and indicate a stock is likely to outperform low-margin counterparts while macro conditions are uncertain and financial conditions are tightening, Kostin said. Here are 10 high-growth, high-margin stock picks from Goldman that have performed well in recent months and should continue to do so "provided narrowing breadth persists." They trade at "only a small premium to similarly high growth companies" with low or negative margins, the firm found. They're Russell 3000 companies, excluding financials, with market caps greater than $5 billion, consensus revenue growth of more than 15% for 2023 and margins over 20% for 2023. Big names like Alphabet and Meta Platforms are on the list, along with Mastercard , which has the highest profit margins for 2023 at 47%. Etsy is the one retail stock named, with a consensus growth rate between 2021 and 2023 of 20% and 2023 profit margins of 21%. Marvell is one of several semiconductor stocks on the list alongside Nvidia. Booking Holdings , Match Group and PayPal are other big names included. Kostin added that given the current macro backdrop, the risk of a major near-term sell-off is low. "While 'unknown unknowns' cause the largest drawdowns and by their nature are impossible to assess in advance, the macro environment does not suggest drawdown risk is elevated in the coming months," he said in the note. "Earnings and margins continue to surpass expectations. Meanwhile nominal and real rates are expected to rise but remain low over the coming months, supporting the backdrop for both valuation and equity demand," Kostin said.

A person in a mask walks by the New York Google offices after they announced they will postpone their reopening in response to updated CDC guidelines during the outbreak of the coronavirus disease (COVID-19) in Manhattan, New York City, U.S., July 29, 2021.

Andrew Kelly | Reuters