(Bloomberg) — Goldman Sachs Group Inc. cut his year-end target for the S&P 500 to 3,600 from 4,300, arguing that a dramatic shift in the outlook for interest rates moving higher would weigh on valuations for US stocks.
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The higher interest rate scenario in Goldman’s valuation model supports a price-earnings multiple of 15 times, compared with 18 times previously, strategists including David J. Kostin said in a note on Thursday. “Our economists now forecast that the FOMC will raise the policy rate by 75bp in November, 50bp in December and 25bp in February for a maximum funds rate of 4.5%-4.75%.
Goldman said risks to its latest forecast remain skewed to the downside because of the growing odds of a recession — a scenario that would reduce corporate earnings, widen the yield gap and push the benchmark U.S. stock index to threshold of 3,150. Federal Reserve Chairman Jerome Powell has indicated he would risk a recession to fight inflation, fueling fears that central banks could derail global growth.
Stock valuations and real returns have moved at the same pace in recent years, but that relationship has degenerated recently, putting stocks at risk, the U.S. investment bank said. It had previously assumed that real rates would end in 2022 at around 0.5%, compared with the 1.5% assumption now.
The majority of equity investors have taken the view that a hard-landing scenario is inevitable, and their focus is on the timing, size and duration of a potential recession, Kostin and his colleagues wrote. Under such a framework, the S&P 500’s 3-, 6- and 12-month targets are achieved at 3,400, 3,150 and 3,750 respectively, they said.
To be sure, the S&P 500 has underperformed the Stoxx Europe 600 Index since Sept. 12, when Kostin and his team said they see the U.S. as a safer bet than Europe. They also say a year-end rally in the U.S. stock index to 4,300 is possible if inflation shows clear signs of easing.
Goldman’s new headline target implies a 4.2% drop in the benchmark U.S. stock index from Thursday’s close. It projects 6- and 12-month targets for the range at 3,600 and 4,000, respectively.
The US bank, like many of its peers, advises that heightened uncertainty calls for a defensive positioning by investors and should hold stocks with quality attributes such as strong balance sheets, high returns on capital and steady sales growth.
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