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 was likely to continue raising interest rates aggressively when it raised the federal funds rate by three-quarters of a percentage point, and indicated that “peak” fed funds rate can reach over 4.5%. The Fed is trying to reign high inflation by reducing economic demand which is are likely to continue to reduce corporate earnings.
Strategists at Goldman Sachs are now lowering their price target for the S&P 500. Strategists see the index trading at 3,600 by the end of the year, down from a previous forecast of 4,300. The new target represents a small drop from the index’s current level of just under 3,700. but the point is that confidence in the market is waning. “The expected path of interest rates is now higher than we previously thought, tilting the distribution of equity market results below our previous forecast,” Goldman’s chief U.S. strategist David Kostin wrote.
Part of Goldman’s equation is that the Fed’s rate hikes have pushed up the “real yield” on 10-year Treasuries. This is the 10-year yield minus the expected average annual inflation expectations for the next 10 years, as investors typically require a rate of return higher than the rate of inflation. The real 10-year yield has risen to just over 1.3 percentage points, and Goldman says it could soon reach 1.5 percentage points.
Consequently, the bank expects relatively low earnings growth forecasts for the S&P 500. It expects aggregate earnings per share for S&P 500 companies to reach $234 in 2023. That’s only a 3% increase from this year’s expected result and is more down from the current total forecast for 2023 of $240, according to FactSet.
However, lower profits are not the only factor weighing on the bank’s forecast. The higher real 10-year yield also lowers valuations. When the real rate of return on safe government bonds rises, it makes the expected return on the riskier stock market look a little less attractive. A real 10-year yield of 1.5 percentage points, historically, should equate to roughly 15.4 times the S&P 500 multiple on next year’s earnings, Goldman says. That’s roughly where the index is currently trading as the stock has sold off a week.
Earnings are what will ultimately determine whether Goldman’s new target proves correct or needs to be cut again.
Write to Jacob Sonnenschein at [email protected]