- Higher interest rates mean a grimmer economic outlook and a further drag on the stock market.
- Goldman Sachs lowered its 2022 projection for the S&P 500.
- The firm says quality, short-duration stocks will outperform long-duration.
On Wednesday, the Federal Open Market Committee raised its key interest rate by 75 basis points for a third straight time.
Their decision lifted the fed funds rate to a range between 3% and 3.25%, the highest since early 2008. And, their median forecast is that this rate will be at 4.4% by the end of this year.
As the fight to squash inflation continues, Wall Street is coming to terms with what higher rates could bring besides less inflation: lower consumer demand that slows the economy, and weaker stock prices. On Friday, concerns about the Fed’s rate hikes pushed the S&P 500 towards its lows of the year.
A day earlier, Goldman Sachs equity strategists cut their year-end target for the index from 4,300, which it hit in mid-August, to 3,600.
“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,” strategists led by David Kostin said in a note.
One of those outcomes is a so-called hard landing in which higher rates trigger a recession. That scenario could see the S&P 500 plunge to 3,400 by year-end, and 3,150 by the end of the first quarter, Kostin said.
A low unemployment rate is signaling that consumer incomes and spending could increase by next year. This scenario would keep inflation elevated and lead the Fed to hike rates further than current projections, he said.
He added that based on the team’s conversations with clients, a majority of equity investors now believe a hard landing is inevitable. What’s still unclear is the timing, magnitude, and duration of a potential recession. Most portfolio managers estimate that a recession could hit the US economy sometime in 2023, according to Kostin.
His team now recommends defensive positioning in light of the unpredictability. Investors should focus on stocks that have strong balance sheets, high returns on capital, and stable sales growth.
Rising interest rates also mean short-duration stocks, those that generate a larger share of their cash flows in the near future, will outperform their long-duration peers, Kostin said. That’s because stocks with cash flows pegged to the distant future are more sensitive to interest rates, he added.
Below is a list of 26 stocks that Goldman added to its newly rebalanced basket of short-duration stocks.