GOLDMAN SACHS: There's a hidden way for investors to score big on tax reform

Reuters / Brendan McDermid

• Goldman Sachs says to look at downtrodden small-cap stocks for stock-picking opportunities in the aftermath of GOP tax reform.
• When the dust around the tax bill settles, the firm says there will be plenty of chances for active managers to identify single stocks with upside potential.

If the biggest firms on Wall Street can agree on one thing these days, it's that the GOP tax bill is going to boost equities in 2018.

JPMorgan recently posted a year-end S&P 500 price target of 3,000 - tied for the most bullish call out there - while citing the positive effect of tax reform. Meanwhile, UBS said earlier this month that the benchmark could hit 3,300 next year, which would mark a 25% surge from when it made the forecast.

But Goldman Sachs has dug a little deeper and identified a way for diligent equity investors to make a killing on a single-stock basis in the wake of the tax bill's successful passage.

It involves small-cap stocks, which are usually more domestically exposed than their multinational counterparts. Because of their US focus, they soared immediately after the presidential election in 2016, and acted as a proxy for sentiment around the tax bill for much of 2017.

But they've been underperforming in recent months due to risk around the limiting of interest deductibility, as well as speculation they won't benefit much from tax cuts, according to Goldman. As such, the firm sees a huge opportunity for active managers to come in and scoop up exposure at bargain prices.

"The complexity of the new tax code means there is much more work and potential benefit ahead for stock pickers as they uncover the specific implications of the tax code for individual industries and companies," Goldman Sachs strategists led by Ben Snider and David Kostin wrote in a client note."The represent opportunities for investors willing to sift through the chaff."

Goldman Sachs Global Investment Research

The Russell 2000 has lagged the broader market in recent weeks, which has created the opportunity to pick single stocks that will rebound.

But the money-making possibilities don't end there. Goldman says that investors willing to be patient should be able to ride the wave higher in high-growth areas that have fallen out of favor in recent weeks. That includes many of the mega-cap tech companies that have seen recent losses as investors have sold stock to fund purchases of shares in companies seen benefiting most from tax cuts, like banks.

Their "fundamental appeal should outweigh the impact of tax reform," says Goldman. Based on forecasts compiled by Bloomberg, the tech sector will grow earnings by 24% in 2018. That's the second-most in the S&P 500, trailing only energy, which adds credence to the firm's suggestion.

Looking more broadly, Goldman sees tax reform as a whole boosting S&P 500 earnings by 5% in 2018. They acknowledge that it's a moving target, and that much will depend on how corporations end up using tax proceeds. One important distinction that the firm makes is that some activities - like cutting prices and raising wages - could ultimately be positive for companies, but won't be accretive to earnings.

Overall, the tax reform aftermath is a puzzle that investors have been left to solve. And as they go foraging for ideas, the recommendations outlined by Goldman offer a great starting point.

Get the latest Goldman Sachs stock price here.