finally decided to stop fighting the Fed and lowered its forecast for the end of the year
The Fed made clear on Wednesday that it is likely to continue raising rates aggressively when it raised the federal funds rate by three-quarters of a percentage point and said the “peak” Fed Funds rate could exceed 4.5% . The Fed is trying to reign in high inflation by reducing economic demand, which is likely to continue to reduce corporate profits.
Now, Goldman Sachs strategists are lowering their price target for the S&P 500. Analysts see the index trading at 3,600 by the end of the year, down from an earlier forecast of 4,300. The new target represents a slight drop from current level of the index just below 3700, but the point is that confidence in the market is weakening. “The expected path of interest rates is now higher than we previously assumed, which skews the distribution of equity market results below our previous forecasts,” writes Goldman’s chief U.S. equity strategist David Kostin.
Part of Goldman’s equation is that the Fed’s rate hikes have pushed the “real yield” on the 10-year Treasury note higher. This is the 10-year yield minus the expected average annual inflation expectations for the next 10 years, as investors typically demand a rate of return higher than the rate of inflation. The real yield on the 10-year has risen to a touch above 1.3 percentage points, and Goldman says it could soon reach 1.5 percentage points.
The bank, therefore, expects fairly low earnings growth estimates for the S&P 500. It expects total earnings per share for S&P 500 companies to reach $234 in 2023. That’s only a 3% increase over expected result this year and is lower than the current 2023 total forecast of $240, according to FactSet.
Lower profits, however, are not the only factor affecting the bank’s forecasts. A higher real 10-year yield also lowers valuations. When the real rate of return on a safe government bond rises, it makes the expected return on the riskier stock market look a little less attractive. A 10-year real yield of 1.5 percentage points, historically, should correlate to about 15.4 times the S&P 500’s earnings over the next year, Goldman says. That’s roughly where the index is trading right now, as stocks have sold off this week.
It’s earnings that will ultimately determine whether Goldman’s new target proves correct or should be cut again.
Write to Jacob Sonenshine at email@example.com