After a record-breaking 2019, Wall Street is expecting 2020 to deliver more modest gains.
While many analysts are expecting a good start to next year on the heels of the phase one trade agreement between the U.S. and China, the average forecast for the S&P 500—which is up 29% for the year—sees -5.6% downside from where the index is today by the end of 2020.
Goldman Sachs (NYSE: GS) chief U.S. equity strategist David Kostin’s target for the index at the end of next year is on the more bullish end at 3,400, or about 5% upside from where the S&P 500 is now. Kostin sees an acceleration in U.S. economic growth next year as trade tensions calm and consumer spending remains strong, an environment that he says will boost investor sentiment benefit value stocks.
“Over short and intermediate investment horizons, the key driver of Growth vs. Value performance is the macroeconomic environment and its impact on investor risk sentiment,” Kostin wrote in a note to clients.
But investors can do better than just tilting their portfolios toward value stocks. Goldman has a portfolio that it expects will triple the market’s return next year.
The firm recommends clients look at stocks with a high Sharpe Ratio, which is calculated by dividing a stock’s expected return on investment in excess of the risk-free rate by the standard deviation of that return.
As an example, if there are two stocks with the same expected return, the one with less volatility has a higher Sharpe Ratio and is a more attractive investment compared to a stock that could give you the same return but not without a higher potential for volatility.
Goldman’s High Sharpe Ratio basket considered analysts’ consensus price targets as well as the six-month implied volatility from option pricing on a given stock for the denominator.
According to Kostin, this basket has outperformed the S&P 500 by nearly six percentage points annually over the last two decades, and has outperformed a broader basket of value stocks in the last few years. Over the next twelve months, Goldman sees this basket generating a median return of 17% over the next twelve months, more than three times the firm’s forecast for the index next year.
‘Our high Sharpe Ratio basket typically has a value tilt and often contains some constituents that have experienced substantial price declines and have high upside to consensus price targets,” Kostin said in the note.
The stock with the highest Sharpe Ratio in Goldman’s basket is Diamondback Energy (NASDAQ: FANG), at 1.2, which analysts say could see 34% upside over the next twelve months. Other names on the list include Alexion Pharmaceuticals (NASDAQ: ALXN), United Airlines (NASDAQ: UAL), Amazon (NASDAQ: AMZN), Comcast (NASDAQ: CMCSA), and VeriSign (NASDAQ: VRSN).