GOLDMAN SACHS: US manufacturers are still poised to dominate the stock market despite signs of a slump. These are the companies that will get the biggest boost.

Marley Jay

Sep 9, 2019, 21:44 IST

GOLDMAN SACHS: US manufacturers are still poised to dominate the stock market despite signs of a slump. These are the companies that will get the biggest boost.

Reuters

Goldman Sachs chief US equity strategist David Kostin says industrial stocks are likely to beat the rest of the market going forward despite signs of a slowdown in US manufacturing.
Many investors see manufacturing as a critical indicator of the health of the US economy, but Kostin writes that the most-closely watched measurement of US manufacturing is usually wrong at predicting economic recessions.
Kostin expects aerospace and defense companies to lead the surge as US defense spending continues to rise, and identifies a handful of stocks that will soar.
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US manufacturing may have just contracted for the first time in years, but Goldman Sachs says now is time to buy exposure to the sector, which is positioned to trounce the rest of the market.

When factory activity falls, investors often fret about the health of the economy and reason that it must be getting worse. But David Kostin, Goldman's chief US equity strategist, says it's more likely stocks will rally. Further, he thinks the industrial sector - which has a high concentration of manufacturers - will lead the way.

That's because, in recent decades, manufacturing slumps in the US have been short-lived and haven't led to recessions. Kostin says he is especially optimistic about aerospace and defense companies, which stand to benefit from rising defense spending by the government.

"During the past 10 years, Aerospace & Defense has been least sensitive to US and global economic growth across Industrials subsectors," he says in a note to clients. "Outside of recessions, Aerospace & Defense has outpaced the S&P 500 by a median of 250 bp during the 6-month period when the ISM fell from 50 to its trough."

The Institute for Supply Management's purchasing managers index is the most closely-watched indicator of US manufacturing, and when it's monthly reading is under 50, it means activity is decreasing.

But Kostin says it has a mixed track record at predicting recessions, and since 1990, it's usually been "wrong." He backs up that point with this chart.

ISM and Goldman Sachs Global Investment Research

Kostin notes that when the ISM gauge contracts and the economy doesn't go into a recession, the S&P 500 usually climbs 6% over the next six months, and 22% over the following 12 months.

In other words, while lower readings do hurt industrial stocks for a time, he says that just sets the stage for future rallies as the economy keeps growing. He expects a similar outcome now, and has a 3,100 target for the S&P 500 at the end of 2019 and 3,400 at the end of 2020.

Kostin details the industrial sector's historic performance this way:

"The sector lags when the ISM falls," he said. "However, Industrials has led the S&P 500 by a median of 110 bp and 210 bp six and 12 months after the ISM has fallen below 50 outside of recessions, driven by Aerospace & Defense," he says."

Kostin's favorites

He says his top picks among industrials are aircraft component maker TransDigm, shipbuilder Huntington Ingalls Industries, and defense contractor Northrop Grumman. Kostin described those as the aerospace and defense stocks with the least exposure to the Asia Pacific region, meaning they're less vulnerable to the US-China trade war.

The other members of the S&P 500 aerospace and defense index are as follows: