Goldman Sachs: Buy these 50 quality stocks for continued outperformance during a pivotal stretch for markets as the Q3 earnings season kicks off

• Stocks and the economy are at a pivotal point as the Q3 earnings season starts.
• Goldman Sachs is cautious about stocks but doesn’t see a recession as inevitable.
• Here are 50 quality stocks to buy now to protect your portfolio from downside.

In late 2020 and for most of 2021, it seemed as if stocks were unstoppable. Bad economic news encouraged the Federal Reserve to keep interest rates low, which caused the prices of risk assets to soar.

The exact opposite has happened in 2022. The economy was running so hot heading into this year that inflation rose to multi-decade highs, which led the Fed to furiously hike interest rates. Now, the better the economy does, the more ammunition the US central bank has to keep raising rates, which will hurt growth and likely cause a recession.

Unlike two years ago, investors now appear to be faced with a lose-lose proposition: either interest rates rise even higher in an economy that’s tepid but still afloat, or the economy collapses, which would surely cause corporate earnings to follow suit. 

Goldman Sachs is urging caution in the face of this gloomy backdrop. The firm’s year-end target for the S&P 500 is 3,600 if there’s a soft landing and 3,400 if the economy slips into a recession.

However, investors shouldn’t give up all hope. Plenty of pain has already been priced into the S&P 500, which is down about 25% from its January peak. That’s about how much the index should fall in a recession, according to Goldman Sachs — and such a downturn is still no guarantee.

Economists at Goldman Sachs still see just a 35% likelihood of a recession in the US in the next year, noted David Kostin, the firm’s chief US equity strategist, in an early October report. Even Fed chair Jerome Powell, who was once a perpetual optimist, isn’t that positive right now.

The next month will be crucial for stocks and the economy. Third-quarter earnings reports from major companies will begin to come out this week, along with a pair of critical releases: minutes from last month’s Federal Reserve meeting on Wednesday and September inflation data on Thursday.

While markets always want to hear what the Fed has to say, it’s the inflation data that will likely determine the next 5% to 10% move for stocks. Inflation that’s fading faster than expected could be stocks’ saving grace, but persistent price surges would surely keep the Fed hiking rates.

50 quality stocks to buy

In this uncertain market environment, investors have flocked to the relative safety of high-quality stocks in droves after ignoring them for years. The result is that many quality companies now trade at a sizable premium compared to the broader market, according to Goldman Sachs, but that hasn’t appeared to hinder their performance relative to the S&P 500.

Below is Goldman Sachs’ current sector-neutral basket of 50 quality stocks that were chosen for their strong balance sheets, solid revenue growth, impressive return on equity, low deviation of earnings before interest and taxes (EBIT), and low drawdown.

Along with each pick is its ticker, market capitalization, sector, expected earnings growth for 2023, and quality score out of 100. Quality score is calculated by weighing each company’s percentile rank based on the following criteria, according to Goldman Sachs: EBIT downside deviation (40%), sales Sortino ratio (40%), 5th percentile drawdown (10%), and average ROE (10%).