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Goldman Sachs

finally decided to stop fighting the Fed and lowered its year-end forecast for the

S&P 500.
 

The Fed made clear Wednesday that it is likely to continue lifting interest rates aggressively when it raised the federal-funds rate by three quarters of a percentage point, and indicated that the “peak” fed-funds rate could get above 4.5%. The Fed is trying to reign in high inflation by reducing economic demand, which is likely to continue denting corporate earnings. 

Now, Goldman Sachs strategists are lowering their price target for the S&P 500. The strategists see the index trading at 3600 by the end of the year, down from a prior forecast of 4300. The new target represents a small drop from the index’s current level of just under 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 tilts the distribution of equity market outcomes below our prior forecast,” 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. That’s the 10-year’s yield minus expected average annual inflation expectations for the next 10 years, as investors usually demand a rate of return higher than the inflation rate. The real 10-year yield has risen to a touch above 1.3 percentage points, and Goldman says it could soon get to 1.5 percentage points. 

The bank, therefore, expects fairly low earnings growth estimates for the S&P 500. It expects that aggregate earnings per share for S&P 500 companies to come in at $234 in 2023. That’s only 3% growth over this year’s expected result and it’s lower than the current aggregate 2023 forecast of $240, according to FactSet. 

Lower earnings, though, aren’t the only factor weighing on the bank’s forecast. A higher real 10-year yield also reduces valuations. When the real rate of return on a safe government bond goes up, it makes the expected return in the riskier stock market look a little less appealing. A real 10-year yield at 1.5 percentage points, historically, should correlate to a roughly 15.4 times S&P 500 multiple on next year’s earnings, Goldman says. That’s roughly where the index is trading at right now as stocks have sold off this week. 

It’s the earnings that will ultimately determine whether Goldman’s new target will prove to be just right—or have to be cut again.

Write to Jacob Sonenshine at [email protected]