A seemingly cheap stock market may not yet be cheap enough given rising risks to corporate profits from red-hot inflation and rising interest rates, Goldman Sachs warns.
“Despite the 18% year to date S&P 500 decline, equity valuations remain far from depressed,” Goldman Sachs Chief U.S. Equity Strategist David Kostin wrote in a new note to clients. “Valuations appear more attractive in the context of interest rates, but still do not look cheap.”
Kostin added that analyst estimates for corporate earnings still look too high while recent news flow from companies has been concerning.
“Valuations dominated investor focus in early 2022, but recent client conversations have centered on risks to EPS estimates, he wrote. “Company announcements have added to these concerns. Just weeks after shares fell by 25% on disappointing 1Q margins, Target cut margin guidance this week as it struggles to manage excess inventory. Investors have also focused on a string of downbeat comments from tech companies. In recent weeks firms including Amazon, Microsoft, and Nvidia have signaled intentions to slow hiring. This development is positive in terms of balancing the labor market but reflects management anxiety about growth and inflation.”
To be sure, the latest spate of economic news has poked a hole in the notion of valuations being attractive despite the market’s pullback.
The Michigan Consumer Sentiment reading tanked 14% in June compared to May, bringing the index to the trough hit in the middle of the 1980 recession, and consumers’ assessments of their personal financial situation worsened about 20%. According to UMich, about 46% of consumers attributed their negative views on their financial situation to high levels of inflation.
The Consumer Price Index, meanwhile, surged 8.6% in May from one year ago. That represented the fastest increase since December 1981.
Economists expect the Federal Reserve to raise interest rates by 50 basis points at its policy meeting this week and signal further aggressive hikes to curb inflation as that would serve as another anchor to stock valuations.
Kostin isn’t entirely bearish on stocks: The strategist views dividend-paying stocks as “particularly attractively valued.”
“Dividend stocks typically outperform in environments of elevated inflation. In addition, dividends currently benefit from the buffer of strong corporate balance sheets,” Kostin wrote.
Several stocks Kostin highlights that have “above average” dividend yields include Morgan Stanley, JP Morgan, Ford, UPS, IBM, Intel, Broadcom and HP.
A woman with an umbrella walks in the rain in the Manhattan borough of New York City, New York, U.S. October 26, 2021. REUTERS/Carlo Allegri