After 499 trading sessions without a 10% correction on the S&P 500, last week's stock market tumble presented many investors with an unfamiliar set of circumstances.
But there appears to be one consensus amid the mayhem: investors are smart to focus on what to buy in anticipation of the eventual recovery instead of focusing on potential downside, according to a note from Goldman Sachs Global Investment Research.
"Market performance following past non-recession corrections suggests investors should prefer cyclical sectors to defensives," analysts noted.
"There have been 16 drawdowns of 10%+ since 1976. Of the 16 corrections, only five occurred around a recession," Goldman wrote. "Of the remaining 11 non-recession episodes, 1987 was the only one that turned into a bear market."
A bear market in stocks would mean the S&P 500 would have to fall below 2300, "which history suggests is unlikely to occur without a recession," analysts noted. "Our economists believe the probability of a recession remains well below average, given strong global GDP growth and loose financial conditions."
During the three months following past corrections, materials have beaten the S&P 500 by a median of 270 basis points. Industrials beat the index in 73% of the periods at a 270-basis point median. Telecom is the worst pick post-correction, lagging the S&P 500 in 64% of periods by a median of 410 basis points, Goldman found.
Low valuation and small-cap stocks historically perform best following a 10% decline, Goldman noted, with its valuation factor handing over a return 63% of the time at 350 basis points on average. Additionally, high volatility beats low volatility in a post-correction environment: low volatility lagged high volatility by 610 basis points on average in 87% of post-correction periods.
Goldman said it recommends investors focus on cyclicals and low labor cost stocks "now that the long-awaited correction has occurred."
"These strategies have dislocated from their fundamental drivers as they underperformed during the market decline," Goldman wrote. "Rising inflation and interest rates should benefit cyclical sectors, such as Financials, relative to bond proxies."
Firms with low labor costs are set to be the most insulated from accelerating wages, which economists at Goldman expect to continue into 2018.
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