Goldman Sachs Recommends Investors to Utilize Sharpe Ratios for 2020

Market experts are expecting more modest gains in 2020 after a record 2019 that saw major indexes reach highs following a U.S.-China trade deal rally in December. While markets are expecting lesser gains in 2020, global investment firm Goldman Sachs says using Sharpe ratios can help investors identify winners in the new year.

“After a record-breaking 2019, Wall Street generally expects much more modest gains for stocks next year,” a CNBC report said. “But for investors looking for ways to beat the market, Goldman Sachs has a portfolio that it expects to triple the market’s return in 2020. The bank is recommending clients stocks with high Sharpe ratios, a measure of a stock’s performance relative to its volatility. Stocks in its 50-name high Sharpe ratio basket are forecast by the firm’s analysts to generate a median 17% return over the next 12 months, about three times the firm’s S&P 500 forecast of 6%.”

“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,” said David Kostin, Goldman’s chief U.S. equity strategist.

According to the report, Goldman utilizes consensus 12-month price targets and options six-month implied volatility to measure Sharpe ratios. By Goldman’s account, it beat the S&P 500′s return by 5.7 percentage points on average within the last 20 years, and beat the market this year by 4 percentage points this year with a return of 32%.

As far as which sectors will outperform in 2020, Goldman cites energy and real estate as industries to watch for potential upside using the Sharpe Ratio metric.

Energy has been in the doldrums this year, especially with the fall of oil prices following a strong 2018. However, the tide could be turning in the favor of energy equities, which is showing itself in the Energy Select Sector SPDR Fund (NYSEArca: XLE). XLE seeks to provide investment results that correspond generally to the price and yield performance of publicly traded equity securities of companies in the Energy Select Sector Index, which includes securities of companies from the following industries: oil, gas and consumable fuels; and energy equipment and services.

As for real estate exposure, one fund to watch U.S. Diversified Real Estate ETF (NYSEArca: PPTY). PPTY seeks to track the performance of the USREX – U.S. Diversified Real Estate Index™. The index was developed in 2017 by the fund’s index provider and the parent company of the fund’s investment adviser and sub-adviser, and uses a rules-based methodology to provide diversified exposure to the liquid U.S. real estate market.

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