Stock Selection and Analysis

Do low interest rates ALWAYS support high equity valuations?

...or are low rates eventually associated with lower valuations?

The relationship between interest rates and equity markets is hugely important, but not necessarily straightforward. As a Director of Asset Allocation in the 1990s, I ran a value-driven TAA strategy which, like the Fed Model, relied heavily on a positive correlation between bond and equity yields. I was aware of the pitfalls of the model, but in its time, the strategy was very successful.

QMA has just released a fascinating paper which examines the relationship between interest rates and equity valuations. Their research suggests that low rates are supportive of higher PEs up to a point, but after that, an extended period of low rates is actually associated with depressed PEs! Instead of worrying that the Fed might raise rates, equity investors should be relieved to see a rate hike in December. For QMA, the focus now should be not on rates, but on growth...

Why Equity Investors Should Worry Less About the Fed (QMA, Nov 2016)
The authors of this paper examine the relationship between equity valuations and interest rates, concluding that when the Fed raises rates in response to an improving economy and rising profits, this supports equity market valuations.

French stock exchange equity market valuations

Equity/Bond Correlation: History and Future Prospects (BlackRock, July 2016)
For most of the period up to 2000, there existed a positive correlation between equity and bond prices but in the period from 2000-2016, the correlation has generally been negative. These papers explore this phenomenon in more detail.

Structural Trends in Equity Market Valuation (Absolute Return Partners)
This document looks at the structural factors that drive equity prices, including Corporate Profits as a share of GDP, dividends and share buy-backs, demographics, interest rates and valuations.

The Risk of Losing Money in both Bonds and Equities (Northern Trust, Aug 2016)
Could investors lose money simultaneously in both bonds and equities? As interest rates creep lower and equity valuations extend further, the risk increases. This paper explores how likely this is and what strategies investors can employ.

The Investment Implications of an Aging World (PGIM, April 2016)
This paper examines aging populations and seeks to identify investment strategy ideas that can be implemented by institutional investors. The current aging trends will have profound implications for individuals, business and governments.

BlackRock's Methodology for Long-Term Return Forecasts (2016)
What investment returns can we expect in the long term across asset classes? This document presents the methodology used to calculate the BlackRock long-term equilibrium capital market assumptions.

Future Equity Patterns and Baby Boomer Retirements (Society of Actuaries)
How will changing demographics impact asset prices? This excellent paper from the Society of Actuaries reviews the evidence from sixty different papers and covers asset classes from equities, fixed income and property.

Equity Risk Premiums: Determinants, Estimation, Implications (Damodaran, 2016)
In this paper, Professor Aswath Damodaran examines ways of estimating equity risk premiums. He considers the economic determinants of ERP, including information uncertainty, perceptions of macroeconomic risk and risk aversion by investors.

The Shiller CAPE Ratio: A New Look (Jeremy Siegel, Oct 2016)
Using the Shiller CAPE ratio, this paper by Jeremy Siegel asks whether recent future equity return forecasts may be overpessimistic following changes to the computation of GAAP earnings.

How to Calculate Expected Returns on Major Asset Classes (Antti Ilmanen, CFA)
In this paper, Antti Ilmanen asks if the calculation of expected returns in fund management can be reduced to a set of patterns that markets generally follow.