Goldman Sachs: Keep Calm and Carry On Buying

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Global stocks may have been on a wild ride of late, but the world's biggest investment bank has told investors they should see rising U.S. Treasury yields as positive and should continue to buy equities.

"While there are certainly risks around QE (quantitative easing) being withdrawn we continue to view rising bond yields as relatively benign for European equities," Goldman Sachs' European research team said in a report released on Thursday.

"Indeed provided it is better growth that is driving yields upwards (which is what we expect) we would argue it is supportive. We find a positive relationship between real yields in the U.S. and European equities."

(Read More: Japan Stocks Dive Ahead of Sensitive US Data)

Federal Reserve Chairman Ben Bernanke gave little away in his testimony before Congress last week, but markets were twitchy both during and after his speech.

Investors were spooked further by the release of the minutes of the latest Federal Open Markets Committee (FOMC) meeting. They revealed that "a number of participants" were willing to scale back the central bank's $85 billion-a-month asset purchases, perhaps as soon as June, if the U.S. economy picks up further.

The yield on a 10-year benchmark treasury ticked above 2 percent as bearish sentiment kicked in and investors feared an end to the extra liquidity provided by central banks that has fueled the recent bull run. The 10-year yields have risen 10 percent in the last week, stabilizing at around 2.1189 percent.

The Nikkei tanked by over 7 percent in the session following the release of the FOMC minutes. This volatility continued as it skidded below the 14,000 mark to a one-month low on Thursday, weighed down by a strengthening yen and volatile Japanese government bond yields (JGBs). The session brought the benchmark's total losses to 14 percent since it plunged on Thursday last week.

(Read More: World Stocks Volatile Amid Uncertainty)

"Yesterday (Wednesday) morning it looked as though the market gods had laid out the pieces on a chess board, in a way that was logical and tidy. Now they have thrown them in the air to land where they please," Kit Juckes, global head of foreign exchange strategy at Societe Generale, said in a morning note on Thursday.

"Welcome to a much weaker Nikkei, the prospect of risk aversion into month-end, accompanied by spread widening, lower yields and bizarrely a slightly softer dollar."

(Read More: Can Japanese Investors Resist 2% Yields in US?)

But Goldman Sachs urged investors to plough onwards and upwards echoing the famous phrase "keep calm and carry on", coined by the British government during the second world war, to be published in case of a Nazi invasion.

"Our economists continue to expect the first hike in the Fed funds rate to occur in early 2016 with the FOMC to start tapering QE in (the first quarter) 2014," Goldman said.

Other investment banks aren't quite so sure. Nomura said in a research note on Wednesday that it expects the U.S. economy to accelerate in the second half of 2013 and assigned a 50 percent likelihood that the FOMC will announce a reduction in the pace of its asset purchases at the conclusion of its meeting in September.

Contrasting it with 1994, when a surprise rise in Fed funds caused a bond bubble to burst leading to a 17 percent sell-off in European equities, Goldman said the rise in Treasurys would be slower and equities today are a lot less vulnerable.

(Read More: European Banks 'Cheapest They've Been in 30 Years')

"European equities had risen by 42 percent in the previous year and were on a P/E (price-to-earnings) of 17 times. Today the market is up 27 percent over the last year, on a P/E of 12 times and at only a 13 percent premium to the 5-year average," it said, adding that cyclicals should be preferred over defensive stocks.

"We still see the most likely outcome as a modest rise in bond yields and reasonable returns on equities."

Correction: A previous version of this story incorrectly referenced Treasury prices in the first paragraph instead of Treasury yields.

By's Matt Clinch. Follow him on Twitter @mattclinch81.