Stocks will significantly outperform bonds in the years ahead as investors get used to interest rates that will rise more than consensus expectations, according to an analysis from Goldman Sachs.
Goldman foresees the Federal Reserve raising rates in the third quarter of 2015 and taking its funds rate all the way to 4 percent eventually, about double the level predicted by many in the market, including bond manager Pimco, which foresees a short-term "neutral" level of half that.
"We forecast a dramatic divergence between stock and bond returns during the next several years," Goldman strategist David J. Kostin and others wrote in a note to clients.
The firm sees the S&P 500 (^GSPC) stock index returning 6.2 percent a year between now and 2018-well below its stellar performance of recent years-when the funds rate hits 4 percent. During that time, Goldman projects the benchmark 10-year Treasury note to return just 1 percent, compared with a 10.8 percent annualized return over the past five years.
At the core of the forecast is expectation that U.S. gross domestic product will accelerate to a 3 percent or more pace in the coming years, a level it has failed to achieve during the entire post-financial crisis economic recovery. That contradicts calls from former White House economist Larry Summers and others that the U.S. is mired in "secular stagnation" and unlikely to post trend growth for an extended period of time.
Goldman disagrees with that thesis and sees the rate on the 10-year note, currently about 2.5 percent, rising to 4.5 percent as the economy grows.
As for the Fed changing from ultra-easy monetary policies, Goldman points out that the market historically has done well in the early stages of previous tightening cycles. Despite recently issuing a "neutral" rating on stocks, Kostin said he expects the S&P 500 to gain 8 percent over the next 12 months. Kostin will be on CNBC's "Squawk on the Street" at 10 a.m. to discuss his call.
Market valuation is about equal to where it has been prior to previous tightening, he argued.
"On a sector level, cyclical equities tend to outperform the index during the lead up to rate hikes, although there are few discernible patterns in the months following rate hikes," Kostin said. "Information technology has outperformed on average, although these results are skewed by the dot-com bubble coinciding with the interest rate hikes of 1999. Excluding information technology, the S&P 500 still averaged a strong 11.7 percent return during the year prior to a rate hike, while the median stock returned 13.1 percent."
Kostin sees inflation, as gauged through the consumer price index, running about 2 percent annually. By the time 2018 rolls around, he projects an S&P 500 level of 2,300, about 19 percent above current levels.
-By CNBC's Jeff Cox
- Investment & Company Information
- Goldman Sachs