Goldman says investors shouldn’t worry about interest rates at these levels

Traders on the floor of the New York Stock Exchange.

Source: New York Stock Exchange

Rising bond yields, which have rocked investors in recent weeks, have lagged far behind anything posing a greater threat to the market, according to Goldman Sachs strategists.

The yields on government bonds with longer maturities have reached the level last seen before the declaration of the Covid-19 pandemic in March 2020. The spike has sparked concerns that faster economic growth could create inflation and pose a threat if the S&P 500 is not at the valuation level seen since the dot-com bubble.

The S&P 500 fell 2.45% last week in an increasingly volatile market environment.

However, Goldman insists that while rates have risen, no danger signals are flashing.

“Investors are asking whether interest rates pose a threat to stock valuations. Our answer is a resounding ‘no,” “said David Kostin, the company’s chief US equities strategist, in its weekly notice to clients.

The 10-year yield on government bonds, which has been used as a benchmark for fixed income mortgages and some other forms of consumer debt, was last trading at 1.43% on Monday morning. That’s less than Thursday’s high of 1.54%, but otherwise it’s the highest since late February 2020 and higher than it was at the beginning of 2021.

It did so at a time when the S&P 500 is trading at 22-fold forward gains, which Goldman says is in the 99th percentile since 1976, suggesting that valuations could pose a threat, especially in an environment of rising interest rates .

However, Kostin notes that investors should view the trend as a shift rather than a threat.

The comparison of the shared return of the S&P 500 with the 10-year return shows valuations only in the middle range – around the 42nd percentile.

In this environment, investors should recognize that various sectors will benefit, Kostin said.

Cyclical stocks with weaker earnings but stronger growth profiles will win defensive games that performed well during the pandemic rally. Areas like energy and industry tend to do better when interest rates rise.

“Unsurprisingly, these cyclical stocks have been positively correlated with both nominal and real interest rates,” wrote Kostin. “In contrast, the extremely long duration stocks have been negatively correlated to interest rates as they are not making profits today and their valuations are entirely dependent on future growth prospects.”

Interest rates would not pose a significant threat to the stocks until the 10-year mark hits 2.1%, he added. Currently, the environment of rising returns and growth is “consistent” with the company’s price target of 4,300 S&P 500 in 2021, a forecast that implies growth of 13% from Friday’s close.

“Looking ahead, investors need to balance the attractiveness of promising companies with the risk that interest rates will continue to rise and recent rotation will continue,” said Kostin. “While secular growth stocks remain the most attractive investments in the long run, these stocks will underperform more cyclical companies in the short term as economic acceleration and inflation continue to raise interest rates.”

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