How do Interest Rates Affect the Market?
(Simple version)
1. Rising #interest #rates slow growth. Cost of capital higher!
Slowed growth & lower profits. Some are more sensitive than others depending on their debt, bus models, etc.
Diminished future valuations.
Margins compressed
(Simple version)
1. Rising #interest #rates slow growth. Cost of capital higher!
Slowed growth & lower profits. Some are more sensitive than others depending on their debt, bus models, etc.
Diminished future valuations.
Margins compressed
2. When gov bonds (safer) offer higher yields, why take on more risk (stocks) unless equities offer higher returns?
💫Bonds are more attractive until stock valuations fall!💫
*This is key! Think P/E has to come down for earnings yields to go UP!
💫Bonds are more attractive until stock valuations fall!💫
*This is key! Think P/E has to come down for earnings yields to go UP!
3. Real Interest Rates affects stock valuation estimates. When rates rise, it diminishes the value of future earnings & reduces stock value.
💫Catalyst in selloff of growth tech & other high growth companies whose value is dependent on future earnings growth💫
💫Catalyst in selloff of growth tech & other high growth companies whose value is dependent on future earnings growth💫
4. Equity Risk Premiums - return an investor expects to earn above that of a risk-free investment and the reason Investors own stocks. In order to offset risk, you expect to earn more than you would on a safer gov bond.
The calculation for the equity risk premium generally involves subtracting the 10-year real yield from expected returns on stocks. 💫When real yields move higher, that lowers the equity risk premium, which means stocks are less attractive.💫
Therefore, with respect to ERP, as bond yields rise then in order to maintain the ERP spread $SPX yields should rise which make valuations and price come down.
PEs come down.
PEs come down.
If PEs come down while Earnings are under pressure due to:
• compressed margins
• diminished future valuations
• less output/vol
• slowed growth
• productivity is down
Then PE ⏬ and E⏬ so we know what happens to P!
• compressed margins
• diminished future valuations
• less output/vol
• slowed growth
• productivity is down
Then PE ⏬ and E⏬ so we know what happens to P!
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