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Rising bond yields that shook investors the last couple weeks are well short of anything that poses a broader threat to the market, according to Goldman Sachs strategists.
Longer-duration government bond yields have hit levels last seen before the Covid-19 pandemic declaration in March 2020. The rise has triggered worries that faster economic growth could generate inflation and pose a threat at a time when the S&P 500 is at valuation levels not seen since the dotcom bubble.
The S&P 500 fell 2.45% last week amid an increasingly volatile market environment.
However, Goldman insists that while rates indeed have soared, they are not flashing danger signals.
“Investors ask whether the level of rates is becoming a threat to equity valuations. Our answer is an emphatic ‘no,'” David Kostin, the firm’s chief U.S. equity strategist, said in his weekly note to clients.
The 10-year Treasury yield, used as a benchmark for fixed-rate mortgages and some other forms of consumer debt, last traded at 1.43% Monday morning. That’s off of the 1.54% peak hit Thursday but otherwise is around the highest seen since late February 2020 and higher than it started 2021.
That has come at a time when the S&P 500 is trading at 22 times forward earnings, which is in the 99th percentile since 1976, according to Goldman, suggesting that the valuations could be a threat particularly in a rising-rate environment.
But Kostin notes that investors should view the trend as more of a shift than a danger.
Comparing the S&P 500 divided yield to the 10-year yield shows valuations only in a mid-range – around the 42nd percentile.
In this environment, investors should recognize that different sectors will benefit, Kostin said.
Cyclical stocks, with weaker earnings but stronger growth profiles, will win over defensive plays that did well during the pandemic rally. Areas such as energy and industrials tend to perform better when rates rise.
“Unsurprisingly, these cyclical stocks have been positively correlated with both nominal and real interest rates,” Kostin wrote. “In contrast, the ultra long-duration stocks have been negatively correlated with interest rates given they generate no earnings today and their valuations depend entirely on future growth prospects.”
Rates won’t pose a significant danger to stocks until the 10-year hits 2.1%, he added. For now, the environment of rising yields along with growth is “consistent” with the firm’s 4,300 S&P 500 price target for 2021, a forecast that implies 13% growth from Friday’s close.
“Looking forward, investors must balance the appeal of promising businesses with the risk that rates rise further and the recent rotation continues,” Kostin said. “Although secular growth stocks may remain the most appealing investments on a long-term horizon, those stocks will underperform more cyclical firms in the short-term if economic acceleration and inflation continue to lift interest rates.”
