This article is from Wind.

Us long-term bond yields are showing signs of rising as the economy recovers and expectations of fiscal stimulus rise, with 30-year yields hitting a high of 2 per cent since March 2020 this week. It is worth noting that despite the rise in yields, U. S. stocks hit new highs overnight. Goldman Sachs Group mentioned this "bizarre" scene in the market recently and analyzed the impact of higher interest rates on long-term bonds on the market.

1. How does the recent rise in interest rates affect the US stock market?

Since Pfizer Inc (PFE.US) announced a valid vaccine candidate in early November, the yield on 10-year US Treasuries has risen nearly 2 per cent. Over the same period, however, the risk premium (ERP) of stocks in the S & P 500 fell more than 40 basis points as investors were confident of an economic recovery, more than offsetting the impact of high interest rates on stock valuations. In terms of net worth, equity costs have fallen by 12 basis points, and the S & P 500 has risen 11 per cent since November 6. The current ERP is 5.7%, but it is still at a high level compared with history.

As Goldman Sachs Group points out, beneath the surface, rising interest rates have prompted investors to pay higher prices for the fastest-growing stocks recently, such as value stocks and cyclical stocks. 'in its basic valuation model, equity duration (long-term growth) is the most important determinant of stock valuations, 'the bank wrote. In fact, the relative importance of equity durations rose to a record high in June 2020, when the yield on 10-year Treasuries was just 0.6 per cent, because the lower discount rate greatly benefits stocks that generate a large portion of their expected cash flow in the distant future. However, as interest rates rise above 1 per cent, the importance of recent performance growth to valuations has increased, while the value of long-term growth has declined. This model is in line with the recent outperformance of value and cyclical stocks because their earnings are expected to grow faster than growth stocks this year, given their low base.

In other words, stock duration remains the most important valuation driver, in line with the current rise in valuation multiples for growth stocks. But the growing importance of recent earnings growth has led to a relatively poor performance of the stock market since November.

2. How fragile is the stock market driven by rising interest rates, break-even inflation or real interest rates?

The most favorable background for equity returns over the past three years has been a period of falling real interest rates and a rise in break-even inflation (as it is now). The average weekly return on S & P 500 stocks in these periods has been + 1.6% since the beginning of 2018. But when break-even inflation rises and real interest rates rise, returns are also above average (+ 0.7 per cent) and the probability of positive returns is roughly the same (74 per cent). In short, the trend of break-even inflation over the past three years, rather than real interest rates, gives a clearer picture of returns.

Goldman Sachs Group later pointed out that the relationship between the S & P 500 and break-even inflation has been positive since 2012. In an era when inflation expectations are low and stable, fluctuations in break-even inflation are often seen as a reflection of growth expectations and changes in risk sentiment. Improvements in growth expectations often correspond to higher break-even inflation, higher earnings expectations and improved investor sentiment, which more than offset the rise in the discount rate. Empirically, this relationship is confirmed by a two-factor regression of the S & P 500 break-even inflation and the rate of return on changes in real interest rates. Since 2018, every increase in the standard deviation of break-even inflation (taking into account changes in real interest rates) has led to an increase of 0.6 standard deviation in the return of the S & P 500. The coefficient was highest during risk aversion events (for example, February 2016, December 2018) and minimum before the market peaked in February 2020.

There is a difference in the relationship between the S & P 500 and real interest rates; while the rise in real interest rates is not generally good, it is not generally disadvantageous (but it still means that the Fed will buy a lot of TIPS for a long time). Unlike break-even inflation, the signal that the beta of the S & P 500 returns to real interest rates fluctuates between positive and negative. Changes in real yields can reflect a combination of economic growth expectations, Fed policies or other factors, so the stock market may be mixed. As a result, for every standard deviation in real yields since 2018, the S & P 500 returns have increased by an average of 0.04 standard deviations. But if you look at the period when real interest rates rise (excluding periods before and after recessions), it is usually difficult for the stock market to absorb the rise in real interest rates driven by Fed policy, but driven by economic growth, the stock market will rise. The best period for the stock market was the period of reflation after the 2016 election and the passage of corporate tax reform at the end of 2017, despite a rise in real interest rates over the same period. The S & P 500 fell during a period of rising interest rates, driven by expectations of Fed tightening, such as the "tightening panic" in 2013 and comments by Federal Reserve Chairman Colin Powell that interest rates have a "long way to go" compared with neutral levels in 2018. As a result, the potential macro drivers of rising real yields may determine their impact on stocks.

3. Is there a "tipping point" between interest rates and stocks?

Given that interest rates are historically low, Goldman Sachs Group believes that current interest rates are still well below the level seen as the "turning point" of the stock market. Another way is to consider the relative valuation of stocks using the yield spread (the yield on US stocks versus the yield on Treasuries with a maturity shorter than 10 years). At current levels, the spread is 330 basis points. Assuming the price-to-earnings ratio remains the same, the yield on the 10-year Treasury could rise to 2.0 per cent, while the relative valuation would remain in the 50th percentile. If the yield on 10-year Treasuries rises to 2.7 per cent, the relative valuation will be at the 67th percentile in history, a level not seen since 2004, leaving the price-to-earnings ratio unchanged.

On the contrary, Goldman Sachs Group predicts that the rate of change in interest rates will become a more meaningful driver for the stock market. The reason is that stocks are usually able to absorb the gradual rise in interest rates. However, when interest rates rise sharply, stocks usually fall on average in a given month, especially when interest rates show two or more standard deviations in a month (equivalent to 36 basis points at today's prices). Similarly, Goldman Sachs Group also found that when interest rates fluctuate sharply by two standard deviations, the correlation between stocks and bonds is usually reversed.

4. Which industries are the biggest beneficiaries of higher interest rates and which will bear the greatest risk?

The S & P 500 industry is usually divided into cyclical (outperforming the broader market when interest rates rise), defensive (underperforming when interest rates rise) and long-term (excluding interest rates). There is a strong negative correlation between defensive markets (such as utilities and household products) and nominal 10-year Treasury yields, while cyclical markets (such as the banking and automobile industries) have a strong positive correlation. For other parts of the market, such as technology, its long-term and special growth curve means that changes in interest rates are unlikely to be the main drivers of returns.

Specifically, Goldman Sachs Group subdivides the sensitivity of various industries to interest rates according to the different components of nominal bond yields. Most industries are similarly sensitive to real interest rates and break-even inflation. Investors who believe that interest rates will rise should hold stocks in the upper right quadrant, such as energy and banks, while investors who believe that interest rates will fall can hold food and beverage, software, real estate and other sectors in the lower left quadrant.

But even if interest rates are on an upward trajectory, they often include intermittent pullbacks, which means that the sensitivity to returns to rising and falling interest rates is also key. This dynamic has been most clearly reflected in the performance of information technology since the beginning of November. The industry performed poorly in the weeks when interest rates rose, but even better in the weeks when interest rates fell. In terms of net worth, nominal interest rates rose by 24 basis points, but information technology actually outperformed the S & P 500 by 1 basis point. Investment maturity and confidence in interest rate movements will play a key role in investors' preference for cyclical, defensive or long-term investment laws.

5. Which types are the biggest beneficiaries of rising interest rates and which types face the greatest risk?

During periods of rising interest rates, growth stocks usually underperform value stocks. Based on the sensitivity of the rate of return to real interest rates and break-even inflation, the absolute values of various types of stocks tend to rise during the period when real interest rates rise and inflation breaks even. However, the more cyclical parts of the market are more correlated with interest rates and therefore perform better on a relative basis.

However, changes in growth rates can only explain a small portion of the relative returns of growth strategies, blurring the relationship. Since 2018, the difference between the growth rate and the monthly rate of return on value has accounted for only 19%, while the difference between the Nasdaq 100 index and the standard & poor's 500 index has accounted for only 7%. By contrast, the ratio of cyclical stocks to defensive stocks is much higher, at 54%. The reason for the low explanatory power may be that other special drivers are more important than changes in growth rates for growth strategies. For example, the widespread use of technology promotes the long-term growth of earnings growth, while in an economic environment with structurally low growth, the demand for growth keeps the valuations of growth stocks at a high level.

6. What is the impact of interest rates on "large technology companies" such as FAAMG?

Four of FAAMG's five stocks have returned more than 70 per cent since their peak in February and have been driven by earnings growth rather than valuation expansion. While investors tend to focus on FAAMG's high valuation multiples, Goldman Sachs Group points out: "it is worth noting that sales (median + 14 per cent) and earnings per share (+ 24 per cent) of the five companies showed positive growth, while sales and earnings per share of the S & P 500 fell by 3 per cent and 14 per cent, respectively." FAAMG benefits from low interest rates, which makes its high-growth cash flow more valuable, as well as a business model that is still in demand during the recession. Amazon.Com Inc's 110 per cent, Facebook Inc's 101 per cent and Microsoft Corp's 94 per cent return are all driven by earnings per share growth. This model is in sharp contrast to some of the best-performing, less-growing stocks of the past year, which are also valued at much higher multiples.

FAAMG shares are attractive in terms of long-term growth, balance sheet strength and short-term growth, which are the three major drivers of valuation in Goldman Sachs Group's model. While the long-term and short-term growth of the top five stocks is attractive, they are also extremely profitable and are one of the strongest balance sheets in the index. These companies continue to meet high growth expectations, in sharp contrast to the biggest stocks during the tech bubble. Just last week, all five companies beat expectations, by an average of 40%.

The long-term growth characteristics of FAAMG mean that changes in interest rates play a relatively limited role in explaining its returns. For macro-driven industries, such as energy or banks, break-even inflation and real interest rates can explain more than 40% of the change in weekly returns. By contrast, these ratio components explain only 10% of the average FAAMG stock return, as defined by their unique long-term growth curve. Unlike the broader index, the relationship between FAAMG's relative returns and break-even inflation and real interest rates has been mixed since 2012. During a widespread recession, FAAMG returns are negatively correlated with break-even and real interest rates.

7. What is Goldman Sachs Group's benchmark forecast for 2021?

Goldman Sachs Group's interest rate strategist expects the nominal yield on 10-year Treasuries to rise to 1.5 per cent by the end of 2021, with most of the increase coming from real yields rather than break-even inflation. They expect Treasury yields to reach 1.85% by the end of 2022, and the Fed will keep yields unchanged until 2024 and begin to scale back its asset purchases in 2022. Although they expect interest rates to rise, their forecasts for 2021 will remain in the third percentile relative to the levels achieved over the past 40 years.

As a result, "stocks are still attractive relative to bond yields". At the same time, in response to investors' concerns about the bubble, Goldman Sachs Group retorted that when ERP approaches 00:00, the current ERP is 5 percentage points higher than the technology bubble: "We have recently highlighted some bubble-like areas in the stock market, but in the end they still account for only a small part of the market capitalization." At the same time, extremely high valuations and smaller growth stocks are at high valuations. "

Finally, despite high interest rates, Goldman Sachs Group expects the S & P; to rise 14 per cent to 4300 points in 2021, but the bank expects "returns to be more profit-driven than valuation-driven". This is noteworthy because most of the returns on the S & P 500 in 2020 were driven by lower interest rates, suggesting that a lower discount rate could offset the underlying effects of a widespread recession. In addition, Goldman Sachs Group expects interest rate hikes in 2021 to be driven by improved economic growth rather than monetary policy.

8. How will the Fed's curtailment of "asset purchases" affect the market?

Goldman Sachs Group expects the Fed to start scaling back its bond purchases in 2022, but many investors believe a strong economic recovery will cause the Fed to start scaling back asset purchases earlier and disrupt the stock market, similar to the "tapering panic" of 2013. During the "taper panic", the s & p 500 initially fell 6%, but eventually resumed its gains. In an appearance in Congress on May 22, then Federal Reserve Chairman Ben Bernanke hinted that the Fed may slow the pace of asset purchases if the economy continues to improve. Then, at the FOMC news conference on June 19, Bernanke said the FOMC expected to appropriately slow the pace of asset purchases later this year. Yields on 10-year Treasuries rose sharply, driven by real yields, with the S & P 500 down 1.4 per cent. As interest rates continue to climb towards 3%, the s & p 500 will struggle to maintain new highs in the third quarter of 2013. In the end, the bull market in the stock market continued to move forward, and the correlation between stock returns and bond yields returned to positive correlation.

On the surface of the market, the rising sectors during the "retrenchment panic" period are different. After Bernanke's first speech on May 22, 2013, nominal yields on 10-year Treasuries rose 26 basis points (1.9% to 2.2%) in a month. The performance of the rising sectors during this period is in line with the traditional relationship between the stock market and rising interest rates. However, bond yields rose 40 basis points in a week after the Fed news conference, with the macro background of risk aversion, in line with the pace discussed earlier. Although small-cap and cyclical stocks have historically been positively correlated with rising interest rates, they have lagged behind. From June 25 to September 5, 2013, these high-beta strategies performed much better than other strategies as interest rates rose. Interestingly, growth stocks continue to outperform the market, even though interest rates are also rising.