Goldman Sachs raised its official 2017 target for the S&P 500 on Wednesday, but still thinks a drop is in the cards for the market benchmark from here. Higher rates will ultimately keep the market in check, the investment bank said.
Goldman raised its year-end target on the S&P to 2,400 from 2,300, noting they expect strong earnings growth from the financial and technology sectors in the second half.
"The slow pace of US economic growth has benefited Information Technology so far in 2017. The YTD return for the sector is double that of the S&P 500 (21% vs. 10%). We expect this trend will persist in 2H 2017 as growth opportunities remain scarce in a modest GDP growth environment," David Kostin, Goldman's chief U.S. equity strategist, said in a note Wednesday.
U.S. economic growth has been mediocre at best. In the first quarter, the U.S. economy grew at an annualized rate of 1.2 percent in the first quarter.
Kostin added that financials should benefit from rising interest rates in the second half and that the sector's low valuation suggests the sector is primed for a rebound.
"Financials is most sensitive to changes in bond yields, as higher rates boost net interest margins. Our interest rate strategists expect that the US 10-year Treasury yield will rise to 2.75% by year-end," he said.
The benchmark 10-year yield rose to 2.24 percent Wednesday, building on Tuesday's sharp gains.
That said, Goldman's new 2017 target implies a 0.8 percent drop on the S&P from its Tuesday close of 2,419.38. Kostin said a rising 10-year yield, coupled with the prospects of accelerating inflation and higher interest rates from the Federal Reserve "will weigh on S&P 500 valuation" as higher rates have been associated with lower price-earnings multiples historically.