Following the latest Federal Reserve meeting and interest rate hike, Goldman Sachs sees a higher path of rates going forward that will weigh on stocks through the end of the year. The firm on Thursday slashed its year-end target for the S & P 500 to 3,600 from 4,300. The current target implies that the index will fall more than 4% through the end of the year from Thursday’s close. Goldman’s new target for stocks takes into account that the Fed’s aggressive interest rate hikes to tame inflation will probably push the U.S. economy into a recession next year. The bank now sees the Fed tightening by another 0.75 percentage point in November, a half-point in December, and one-quarter point in February. “The forward paths of inflation, economic growth, interest rates, earnings, and valuations are all in flux more than usual with a wider distribution of potential outcomes,” wrote David Kostin in a Thursday note. “Based on our client discussions, a majority of equity investors have adopted the view that a hard landing scenario is inevitable and their focus is on the timing, magnitude, and duration of a potential recession and investment strategies for that outlook.” Real Rates Equity valuations have also closely tracked real interest rates until recently, but the narrowing gap between the two is cause for concern, creating a “vulnerable backdrop for equities,” Goldman said. Real yields have jumped to 1.3% from 0.4% this year, and could reach 1.5% by the end of the year. “For context, real yields were negative 1% at the start of the year when the S & P 500 index hit an all-time high of 4800 and traded at a P/E of 21x,” wrote Kostin. “The tightest yield gap between equities and rates since the pandemic further tilts the balance of risks to the downside.” EPS slump Goldman also lowered its estimates for 2023 S & P 500 earnings per share to $234, which represents modest 3% growth from 2022. “Our earnings estimates are 3% below bottom-up consensus ($241) and in coming months we expect negative revisions to consensus estimates,” said Kostin. “Our reduced price target is entirely driven by higher interest rates and therefore lower valuation.” In the “hard landing” scenario feared by its clients where the Fed tips the economy into a recession, Goldman forecasts the S & P 500 would fall even further to 3,150, or 16% lower from here. To be sure, if inflation eases sharply in the near-term, however, the index could still rally to 4,300 by the year’s end, the firm said. With this backdrop, Goldman recommends investors play higher real rates by snapping up short-duration equities as well as shift their portfolio balance towards quality stocks.
