- Higher interest rates mean bleak economic prospects and a further drag on the stock market.
- Goldman Sachs lowered its 2022 forecast for the S&P 500.
- The company says short-term quality stocks will outperform long-term stocks.
On Wednesday, the Federal Open Market Committee raised its key interest rate by 75 basis points for the third time in a row.
Their decision pushed Fed Funds interest rates to a range between 3% and 3.25%, the highest since early 2008. And their median forecast is that it will hit 4.4% by the end of this year.
As the battle to curb inflation continues, Wall Street is coming to terms with what higher rates could bring alongside less inflation: lower consumer demand slowing the economy, and weaker stock prices. On Friday, concerns about Fed rate hikes caused the S&P 500 to its lows of the year.
A day before, Goldman Sachs stock strategists lowered their year-end target for the index from 4,300, which it reached in mid-August, to 3,600.
“The projected yield path is now higher than we previously assumed, bringing the distribution of stock market results below our previous forecast,” strategists led by David Kostin said in a note.
One such outcome is a so-called hard landing in which higher rates trigger a recession. In that scenario, the S&P 500 could drop to 3,400 by the end of the year and to 3,150 by the end of the first quarter, Kostin said.
A low unemployment rate indicates that consumer incomes and spending could rise next year. This scenario would keep inflation high and lead the Fed to raise interest rates beyond 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 is still unclear is the timing, extent and duration of a potential recession. Most portfolio managers estimate that a recession could hit the US economy sometime in 2023, Kostin said.
His team now recommends defensive positioning in light of the unpredictability. Investors should focus on stocks with strong balance sheets, high returns on capital and stable revenue growth.
Rising interest rates also mean that short-term stocks, which generate a larger portion of their cash flows in the near future, will outperform their long-term peers, Kostin said. That’s because stocks with cash flows linked to the distant future are more sensitive to interest rates, he added.
Below is a list of 26 stocks Goldman has added to its newly rebalanced basket of short-term stocks.