Goldman Sachs: Rising Rates Don’t Kill Bull Markets—Earnings Growth Is What Matters

TREE NEWS reports: Wall Street is gripped by “high-rate panic” as the 30-year Treasury yield surges to 5.3%, a near 20-year high, and the 10-year approaches 5%. But Goldman Sachs offers a starkly different take: rising interest rates do not equal a stock market crash. Earnings growth, not rates, is the true engine of a bull market.

In a September 11 research note, Goldman Sachs argues that high rates are a headwind, not a bull-market killer. As long as earnings growth remains strong and corporate balance sheets stay healthy, the U.S. equity bull market has a solid foundation to continue.

The bank notes that while the S&P 500 forward P/E has fallen from 22x at the start of the year to 19x, the equity risk premium has held steady at around 3%, meaning stocks remain reasonably attractive relative to bonds. History shows that in the first three months after a Fed rate hike cycle begins, the S&P 500 averages a 2% drawdown, but 12 months later, the average return is +9%. Goldman economists expect the Fed to hike another 25 basis points next week.

Valuation Compression Has Occurred, but Stock-Bond Relative Appeal Is Stable

The S&P 500’s forward P/E has dropped from 22x to 19x this year, driven by AI-related uncertainty, doubts about earnings sustainability, and rising rates. Yet Goldman’s analysis reveals a key fact: the relative attractiveness of stocks versus bonds has not materially deteriorated. The earnings yield on the S&P 500 (5.2%) minus the real 10-year Treasury yield (2.6%) gives a spread of 270 basis points, which has been stable over the past two years. The equity risk premium implied by Goldman’s dividend discount model (DDM) is about 3%, also relatively stable.

This means that while rising rates have compressed absolute valuations, they have not systematically undermined the allocation case for stocks over bonds—a key pillar of Goldman’s bullish stance.

Historical Pattern: Early Tightening Hurts, but 12-Month Returns Average +9%

The 10-year Treasury yield jumped to nearly 5% this week, the highest since October 2023, while the 30-year yield rose to 5.3%, near a two-decade peak. Goldman economists expect the Fed to hike another 25bp at next week’s FOMC meeting following stronger-than-expected CPI data.

Goldman rates strategists attribute the rise in long-end yields to higher oil prices, repricing of the Fed’s hiking path, strong economic growth, and the AI investment boom. A key buffer: the rates market has already priced in more than three 25bp hikes by mid-2027, raising the bar for further hawkish surprises.

Goldman’s historical analysis of seven rate hike cycles since the 1990s shows:

In the first three months after the first hike, the S&P 500 averages -2%, with only a 29% chance of positive returns.
Twelve months after the first hike, the average return is +9%, positive in every cycle except 2022.

The 1997 case is instructive: the Fed hiked just 25bp, the S&P 500 fell 10%, but once the market stopped pricing further tightening, stocks bottomed and rallied to new highs within three months. The medium-term impact of rate hikes ultimately depends on how monetary tightening affects earnings growth—the core driver of stocks. Goldman forecasts S&P 500 EPS of $340 in 2026 (+24% y/y) and $385 in 2027 (+13% y/y).

Stocks Are More Sensitive to Long-End Rates; Rate Volatility Is an Additional Risk

Stocks are essentially a claim on long-term future cash flows. Goldman’s DDM shows that 75-80% of the S&P 500’s present value comes from cash flows beyond 10 years (terminal value), making equities most sensitive to the 30-year Treasury yield. Moreover, not just the level of rates but also rate volatility is a key risk. Historically, when rate moves exceed two standard deviations—currently about 40-50bp in a month for the 10-year—stocks struggle to digest the move. The recent rapid rise in rates is a key reason for equity market pressure.

Corporate Balance Sheets Are Healthy; Large-Cap Fundamentals Are Solid

Goldman notes that S&P 500 companies are well insulated from rising rates:

Most have fixed-rate, long-duration debt, so actual borrowing cost increases are limited.
The index’s interest coverage ratio is in the 99th percentile of the past 20 years; the median stock is in the 68th percentile.
Interest expense remains small relative to strong corporate profits.

However, small and mid-cap companies are more vulnerable, with weaker balance sheets and higher floating-rate debt.

Corporate Response: Growth Is Key to Defending Valuations; M&A and AI Investment Accelerate

Goldman’s model quantifies the trade-off: a 1 percentage point rise in the cost of equity requires a 2 percentage point increase in long-term growth expectations to fully offset the valuation hit. This pressure is driving several corporate strategies:

Higher capex and R&D: About half of S&P 500 companies discussed using AI to boost productivity on recent earnings calls, while others plan to use AI to open new revenue streams.
Accelerating M&A: U.S. announced M&A volume year-to-date is $1.4 trillion, with global volumes up 36% y/y. M&A is a fast way to improve growth trajectories.
Spin-offs and divestitures: After a lull, rate pressure may push more companies to shed low-growth or non-core businesses to “slim down for growth.”

Key Takeaways for Investors

Don’t panic over high rates alone. Earnings growth is the primary driver of long-term equity returns. Focus on companies with strong earnings visibility and healthy balance sheets.
Favor financials and high-growth names. Goldman recommends avoiding rate-sensitive homebuilders and embracing financials and companies with strong growth potential.
Watch rate volatility, not just levels. Sharp moves in long-end yields can pressure stocks even if the absolute level is not extreme.
Small caps are more vulnerable. Their floating-rate debt and weaker balance sheets make them more sensitive to rising rates.
AI and M&A are key themes. Companies using AI to boost growth and those pursuing strategic M&A may be better positioned to offset valuation compression.