Strategist David Kostin and team cut their 2022 market price target to 3,600 from 4,300. The market is now pricing in a 4.6% terminal fed funds rate after the FOMC decision this week, up from 3.25% when the previous target was set.
In the case of soft landing in 2023, Kostin forecasts that the S&P ends the year at 4,000. A hard landing would see it finish at 3,750.
The benchmark index closed below 3,760 on Thursday and is looking at another down day and five losing weeks out of six.
“The S&P 500 index actually reached our previous year-end target of 4300 in mid-August, but the rate complex has subsequently shifted dramatically,” Kostin wrote in a note late Thursday. “The higher interest rate scenario that we now incorporate into our valuation model supports a P/E of 15x (vs. prior forecast of 18x).”
“Equity valuations have closely tracked real interest rates until recently,” Kostin said “Real yields have soared from 0.4% to 1.3% during the past month and could reach 1.5% by year-end. 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. The tightest yield gap between equities and rates since the pandemic further tilts the balance of risks to the downside.”
Pivotal event approaching
Investors should turn their attention to earnings now, Goldman recommends.
“The surprisingly high August inflation reading was a pivotal event for macro investors regarding the path of Fed hikes,” Kostin said. “The analogue for stock investors is 3Q earnings season where record high profit margins will be under scrutiny.”
Goldman recommends defensive positioning amid uncertainty. With surging rates short duration will outperform long duration and investors should own stocks with “quality” characteristics like strong balance sheets, stable sales growth and high returns on capital.
See AllianceBernstein’s in-depth guide to identifying quality stocks.