- The 2-10 year yield curve inverted on Friday, flashing risk signals of a recession.
- However, stocks have typically produced positive returns in the two years following an inversion.
- Goldman Sachs strategists shared 35 highly profitable growth stocks they wanted to own amid macro headwinds.
The most-watched part of the yield curve dipped into negative territory on Friday after briefly inverting on Wednesday for the first time since 2019, flashing risk signals of an imminent move
Like many on Wall Street, strategists at Goldman Sachs have noticed the rapidly flattening yield curve and recently decided to raise their forecasts for 2-year and 10-year Treasury yields to 2.9% and 2.7% for the year, respectively % to end, according to a Friday research note for customers.
Since 1965, the 2- and 10-year portions of the yield curve inverted a median of 20 months before the onset of each recession, with the most recent fall being August 2019. However, Goldman strategists say its asset indicators point to a 38% chance of a recession within the next two years.
The basis for their relatively positive outlook is the record high inflation in the USA.
“The nominal curve tends to invert more easily in high-inflation environments, meaning it would take a deeper nominal curve inversion than in recent cycles to generate a comparable recession signal,” wrote the team led by Chief Equity Strategist David Kostin in the message.
Perhaps more importantly, the S&P 500 has typically generated positive returns in the two years since the yield curve inverted, returning a median of 2% over three months, 3% over six months, and 9% over 12 months, according to the strategists .
“This pattern reflects the lag between the inversion of the yield curve and the onset of the recession, during which stocks typically continue to post positive returns,” they wrote in the note.
Still, strategists pointed to what transpired in the 1970s – a comparable period of high inflation – as an example of the great downside risk facing equity investors today.
After the 2- and 10-year portions of the yield curve inverted in 1973, the S&P 500 fell into negative territory over the following three, six, and 12 months, and eventually into one
which fell 48% in nominal terms and 57% in real terms, they said.
Stick to high-profit growth stocks
While it may be too early to tell, the S&P 500 has proved resilient so far, gaining 0.2% last week while up 9% since Friday from the March 8 low. Goldman strategists expect the S&P to rise 3.7% to end 2022 at 4,700.
With persistently high inflation, a protracted war in Europe and rising interest rates, strategists continue to recommend investors to hold high-yield growth stocks versus unprofitable longest-duration growth stocks. The latter made a comeback as a result of resuming retail buying, hedge funds covering short positions and the fact that valuations were seen as attractive compared to the past.
Although high-margin, high-growth stocks typically trade at a valuation premium compared to their low-margin counterparts, they now trade at the same average valuation as high-growth stocks with little or no profitability, the strategists noted.
“Given our forecast of tightening financial conditions and slowing economic growth, we believe investors will increasingly differentiate between growth stocks based on ‘quality’ attributes such as margins,” they wrote.
To do this, the strategists have rebalanced the bank’s basket into high-margin, high-growth stocks—stocks that generate a high proportion of earnings relative to their earnings. They are ranked in ascending order of their expected consensus profit margins in 2023, which range from 20% to 57%. The 35 stocks are listed below, along with their tickers, market caps, and expected profit margins.