From a Goldman Sachs research note, in a section entitled “Conversations we are having with clients: Improving fundamentals and the neutral rate” … in brief (bolding is mine, but the note is interesting as a whole):

  • The prospect of higher short-term interest rates is now within the investment horizon of many fund managers for the first time since before the financial crisis
  • Both the futures market and Goldman Sachs Economics anticipate the initial hike will occur in roughly 12 months (3Q 2015)
  • Kansas City Fed … annual Jackson Hole economic symposium … investors will look for information on how policymakers will assess when tightening should begin
  • Markets do not always follow historical patterns, but we expect the S&P 500 will climb by 6% during the next year, ahead of the first hike
  • S&P 500 posted positive returns during the 3, 6, and 12 months ahead of first Fed tightening actions in 1994, 1999, and 2004.
  • Compared with prior episodes, the level of interest rates is much lower and the trajectory of economic recovery is far more gradual. However, the starting forward P/E multiple on an aggregate basis is actually lower than it was in 2004 (15.5x vs. 16.4x), although on a median basis it is similar (16.6x vs. 16.4x).
  • US economic growth is improving. The Goldman Sachs Economics Current Activity Indicator (CAI) – a high frequency measure designed to reflect the underlying pace of GDP growth – suggests the US economy is expanding at a 3.5% pace. Nonfarm job creation has averaged 230,000 per month during the first seven months of 2014 up from an average of 194,000 in 2013 and 186,000 in 2012. The unemployment rate has dropped from 6.7% at the end of last year to 6.2%. ISM manufacturing index climbed to 57.1 (highest in three years) while the ISM non-manufacturing index has reached 58.7, the highest level in nine years.
  • Company-level data suggest the business environment is strengthening. In our recently published S&P 500 Beige Book that reviewed the transcripts of 2Q conference calls, managements across many industries noted improving trends and expressed confidence that the acceleration would continue during the second-half of 2014 and into 2015.


  • Goldman Sachs Economics forecasts the Fed will start lifting the funds rate in 3Q 2015 and continue hiking until it reaches a neutral level of 4.0% in 2018. However, some market participants believe the US economy is experiencing “secular stagnation” and GDP growth will remain below trend indefinitely. In that situation, the neutral fed funds rate will be lower than we anticipate, perhaps only 2%.
  • The neutral fed funds rate matters for equity investors. A lower neutral rate in five years translates into a lower discount rate on future earnings and a higher equity valuation. On the other hand, a higher neutral rate means a higher discount rate and a lower present value of future earnings. From a sensitivity perspective, a 50 basis point shift in the estimated neutral rate will adjust our year-end 2018 DDM-implied fair value of the S&P 500 by roughly 9%.