Investors who are convinced that the economic recovery is gaining more traction are going for cyclical stocks in a big way. These are the pros who are forecasting huge gains in the country's GDP and corporate earnings.
Leading this new pack of bulls who forecast a big leap in the U.S. economy and the stock market are the economists and analysts at Goldman Sachs (GS). They've a compiled a large batch of their "best-idea" stocks that they're convinced will outperform the market in 2011 based on these companies' leverage with a forceful economic recovery.
Goldman's optimistic forecasts for U.S. GDP are above consensus for 2011 at 3.4% vs. 2.6%, and for 2012 at 3.8% vs. 3.1%. For the S&P 500-stock index, Goldman raised its year-end 2011 forecast to 1,500, which represents a potential total return of 21%, including a 2% dividend yield. Goldman's three-month and six-month interim targets for the S&P 500 are 1,325 and 1,400, respectively.
The reaccelerating U.S. economy, Goldman analysts argue, will spur 8% sales growth and explains their pro-cyclical recommendations.
An Undervalued S&P 500
"Our economics research colleagues expect the U.S. economy will be 5% larger in nominal terms than today ($15.3 trillion vs. $14.7 trillion)," says Goldman in a study written by analysts David J. Kostin, Stuart Kaiser, Amanda Sneider and Yi Zhang. They also expect the earnings of companies in the S&P 500 to reach a new high that's 5% above its prior peak.
Corporate profits as measured by the S&P 500 estimated earnings are expected to be 11% higher, and yet the S&P 500 ended 2010 at just 1% above the level at year-end 2005. The S&P 500's forward price-earnings multiple, note the analysts, has contracted by 15% to 13.1 times, from 15.4%.
So, all that adds up to the S&P 500 being quite undervalued, and Goldman forecasts the index will rally by 19%, to its target of 1,500 by year-end 2011.
"Focus on stocks with high beta [that is, highly correlated] to both the U.S. economy and the stock market, and firms with rising with rising return on equity," advises the Goldman team.
Favored Sectors and Stocks
What sectors should benefit from the economic rebound? The list reads like sectors that investors have been avoiding: In the U.S., Goldman would bet on shares of companies in the scorned real estate business, banks and diversified financials and insurance companies that have been associated with the financial meltdown, transportation and that unpopular industry, media.
In the global economy, the favored sectors are autos and related industries, materials and semiconductors, capital goods, energy, consumer durables and apparel, and tech hardware and equipment.
Goldman's analysts list 20 names that they recommend among the cyclicals in those sectors. The top 10 are blue chips that are very familiar to investors:
Exxon Mobil (XOM), Apple (AAPL), General Electric (GE), IBM (IBM), Chevron (CVX), JPMorgan Chase (JPM), Wells Fargo (WFC), Bank of America (BAC), Berkshire Hathaway (BRK.B) and Intel (INTC).
Unattractive Sectors and Stocks to Dump
Which stocks should be avoided? Goldman underscores the so-called defensive stocks, to which investors flock when the economy is going down the drain, led by shares of food, beverage and tobacco companies. Also in that down list are the software, consumer services, household and personal products, pharmaceuticals, biotechs and life sciences. Tagged as unattractive as well are retailers, utilities, telecom services, health care equipment and staples retailing.
Naming names in these "should-avoid" sectors, Goldman comes up with stocks that are high on the list of institutional favorites, but which it believes should now be dumped. They're led by Microsoft (MSFT), Google (GOOG) and Procter & Gamble (PG). Also included among the ugly ducklings are AT&T (T), Johnson & Johnson (JNJ), Coca-Cola (KO), Pfizer (PFE), Oracle (ORCL), Walmart (WMT) and Merck (MRK).
Investors may argue that the once-mighty and infallible Goldman Sachs no longer has the credibility and influence it once had. The advent of the catastrophic financial meltdown and the congressional hearings that followed, in which Goldman and its top executives were excoriated and lambasted, damaged the firm's reputation far and wide.
Nonetheless, Goldman, which used to be among the most secretive organizations on Wall Street, is now starting to share part of its closely held research -- probably in an effort to become more transparent. And to be fair, Goldman Sachs's market and economic research still stands out as among the finest -- if not the best -- on Wall Street.