Traders on the floor of the New York Stock Exchange.
Source: New York Stock Exchange
Rising bond yields that have shaken investors over the past two weeks are far above any wider threat to the market, according to Goldman Sachs strategists.
Longer-term government bond yields reached levels last before the Covid-19 pandemic was declared in March 2020. Growth has raised concerns that faster economic growth could generate inflation and pose a threat at a time when S&P 500 is at rating levels, not seen since the dotcom balloon.
The S&P 500 fell 2.45% last week amid an increasingly volatile market environment.
However, Goldman insists that while rates have indeed risen, they are not intermittent signs of danger.
“Investors are wondering if the level of interest rates is becoming a threat to equity valuations. Our answer is an ’emphatic’ no,” said David Kostin, the company’s chief US strategy strategist, in a weekly note to clients.
The 10-year Treasury yield, used as a benchmark for fixed rate mortgages and other forms of consumer debt, was last traded at 1.43% Monday morning. This is outside the biggest hit of 1.54% on Thursday, but otherwise is around the highest level since the end of February 2020 and higher than it started in 2021.
This came at a time when the S&P 500 was trading at 22 times higher earnings, which is in the 99th percentile of 1976, according to Goldman, suggesting that valuations could be a threat, especially in an environment with increasing rate.
But Kostin notes that investors should see this trend as more of a change than a danger.
Comparing the S&P 500 split yield with the 10-year yield shows valuations only in a medium range – around the 42nd percentile.
In this environment, investors should recognize that different sectors will benefit, Kostin said.
Cyclic actions, with weaker gains but stronger growth profiles, will win defensive games that did well during the pandemic rally. Areas such as energy and industry tend to work better when rates rise.
“Surprisingly, these cyclical stocks have been positively correlated with both nominal and real interest rates,” Kostin wrote. “In contrast, long-term equities have been negatively correlated with interest rates, as they do not generate gains today and their valuations depend entirely on future growth prospects.”
The rates will not pose a significant danger to stocks until 10 years reach 2.1%, he added. For now, the yield growth environment, along with growth, is “consistent” with the company’s 4,300 S&P 500 price target for 2021, a forecast that implies a 13% increase since the close of Friday.
“Looking ahead, investors need to balance the attractiveness of promising companies with the risk that rates will continue to rise and the recent turnover continues,” Kostin said. “Although secular growth stocks may remain the most attractive investments on a long-term horizon, those stocks will outperform more cyclical firms in the short term if economic acceleration and inflation continue to drive interest rates.”