Goldman Sachs recommends these stocks if the trade war heats up

Goldman Sachs

With the chance of the U.S.-China trade war heating up, the possibility of further escalations remains a painful possibility for investors. Although the Trump administration recently backed off on tariffs with China, with the stock market surging in response to this easing of tensions, investors still need to be prepared should the worst-case scenario become a reality.

In this regard, one of Wall Street’s top investment banks issued their recommendations for which industries and stocks to look out for under such market conditions.

Goldman Sachs’ strategy team, led by analysts David Kostin and Ben Snider, issued a report where they suggested investors buy stocks of service companies with low labor costs, as they would more easily absorb tariff hikes that would end up increasing the cost of labor.

“The outlook for U.S.-China trade has collapsed,” the Goldman Sach analysts wrote, saying that markets are now pricing in a 13 percent chance of a trade deal, drastically below the 80 percent chance seen in April. Goldman Sachs warns that they won’t expect a trade deal to take place until after the 2020 presidential election. This could be particularly challenging in the short term as a deadline for the dispute of Huawei is approaching. “Huawei sales outside of China will face risk immediately after August 19th because most customers will not purchase a smartphone from a manufacturer prohibited from updating the operating system,” added the analysts.

With all this going on, Kostin and Snider have two-main recommendations. Firstly, is to focus on service companies rather than goods-producing companies. Manufacturers are more easily impacted by trade tariffs, while service providers have less “foreign input costs that might be subject to tariffs” and less at risk of retaliatory tariffs from China.

Helping prove this case, service stocks have largely outperformed goods stocks by around 5 percent on average. The other strategy involves buying stocks with low labor costs, as falling interest rates alongside mediocre economic growth will end up putting upward pressure on wages. According to Goldman Sachs, companies with wages equalling to 5% of their revenue are better protected then high-labor stocks, where wages cost up to 29% or more of revenues. At the same time, low-labor-cost stocks are cheap, trading on average around 12 times forward earnings in compared to 20 times forward earnings for a comparable basket of high-labor-cost stocks.

As for specific stock picks that meet these criteria, Kostin and Snider listed a few for each strategy. Leading service stocks, according to the analysts, includes Microsoft (NASDAQ: MSFT), Amazon (NASDAQ: AMZN), Berkshire Hathaway (NYSE: BRK.A) , Facebook (NASDAQ: FB), JP Morgan (NYSE: JPM), Visa (NYSE: V), and Walmart (NYSE: WMT). As for low labor cost stocks, these include Netflix (NASDAQ: NFLX), PayPal (NASDAQ: PYPL), Cigna (NYSE: CI), Aflac (NYSE: AFL), and McKesson (NYSE: MCK).

However, on the absolute worst-case scenario where both countries use all the economic levels at their disposal, there really won’t be many shelters from the financial fallout in equities as all stocks will more or less fall under an economic doomsday. However, as long as the trade war remains somewhat restrained, staying in the realm of tariffs and the like, looking at companies from these two perspectives are what Goldman Sachs recommends for investors.