6 top investments to make now as a shocking selloff creates buying opportunities

• A jaw-dropping drawdown caught bulls off guard, but US stocks are already rebounding.
• The S&P 500 tends to bounce back strongly after 5% pullbacks.
• Here's where to invest, according to top strategists at firms like Goldman Sachs and Morgan Stanley.

History is on stocks' side after a stunning collapse marked by rare volatility, as is Wall Street.

Leading investment strategists remain cautiously optimistic after the sharpest market selloff in recent memory. The S&P 500 plunged 3% on Monday in its worst day since September 2022, extending its loss in the first three days of August to 6.1%.

But investors are confidently buying the dip, and if the past repeats, they'll be rewarded for it.

"Historical experience shows that investors typically profit when buying the S&P 500 index following a 5% sell-off," wrote David Kostin, the chief US equity strategist at Goldman Sachs, in an August 5 note.

Goldman Sachs found that the S&P 500 usually follows a 5% pullback from its peak with a mid-single-digit gain in the next three months, rising in about 80% of such scenarios since 1980. The index's track record is more spotty after a 10% correction, though it has still done well in the next 12 months when the US economy avoids a recession, as it's still expected to.

It's also worth noting that although major drawdowns are uncomfortable, they're not uncommon. In a typical year, the S&P 500 usually suffers a 14% peak-to-trough decline, according to Truist, though it rebounded from its annual lows in 33 of the last 40 years by an average of 13%.

A sizable selloff should be even less of a shock following a furious multi-month rally, Truist investment chief Keith Lerner recently noted. The strategist expects US stocks to struggle in this seasonally weak late-summer stretch, though he's still confident in their long-term outlook.

"The bull market deserves the benefit of the doubt," Lerner wrote in an August 5 note. He later added: "It's too early to say the low is in. There has been damage done, and the repair process will likely take time. However, the risk/reward appears to be gradually improving as the market's bar for positive surprises resets lower."

6 top places to invest during this selloff

While many top investment firms agree US stocks have upside, there are several different ideas about how to play a potential rally.

Goldman Sachs and Truist recommend defensive stocks in the communication services and utilities sectors. Lerner is focused on communication services' strong earnings and technical trends, along with utilities' enticing valuations — even after a significant rally throughout July.

Kostin, who also advocated for consumer staples, had a slightly different thesis. The strategy chief noted that those economically agnostic groups tend to rise as slower economic growth encourages the Federal Reserve to cut interest rates, as it's almost guaranteed to next month.

"The start of Fed rate cutting cycles are typically characterized by defensive sector outperformance, similar to the rotation that has occurred during the past week," Kostin wrote.

Mike Wilson, the chief US equity strategist at Morgan Stanley, is on the same page. His cautious approach is centered around defensive stocks, plus large caps.

Companies that can hold up in any economic backdrop have stayed strong relative to cyclicals as the labor market loses steam, as Wilson wrote in an August 5 note that "the market has been increasingly attentive to growth slowing."

And although conventional wisdom says lower rates will help economically sensitive companies and small caps most, Wilson's research has led him to an antithetical conclusion.

"While this may seem like a recipe for cyclical and small-cap outperformance, history suggests market leadership around rate cuts is largely the opposite with defensives and large caps showing relative strength," Wilson wrote. "The reason for this is that smaller-cap and lower-quality cyclicals tend to be economically sensitive and dependent on pricing power."

Fading inflation implies companies can't pass on higher costs to consumers, and small caps may be hurt most since they don't have the same scale as their larger competitors. If Wilson is right, small caps' long-awaited rally may be short-lived.

"While we don't necessarily expect small caps to underperform large caps as much as they have over the past few years, we still see relative downside for the Russell 2000 ahead given the deteriorating consumer and labor environment discussed above and the fact that smaller-cap stocks are generally much more economically sensitive," Wilson wrote.

Meanwhile, top minds at UBS Global Wealth Management are going on offense, albeit cautiously, by hunting for high-quality growth, including leading artificial intelligence stocks, which have been hit especially hard recently after dominating for most of the year.

"We maintain our positive view on the AI growth story and think that the recent share-price correction offers a good opportunity to add exposure to leading AI beneficiaries in the semiconductor, software, and internet space at more reasonable valuations," Solita Marcelli, UBS GWM's chief investment officer, Americas, wrote on August 5.