Lower rates are significant drivers of valuation

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Livewire Markets

Interest rates represent the time value of money or the rate at which people are prepared to trade off present for future consumption. It significantly impacts the value of equities, being the present value of future cash flows. To the extent that lower bond yields represent lower inflation or weaker structural growth prospects, then this will have an offsetting impact and may mean that equity values don’t change. In the present environment where quantitative easing has pushed down government bond yields relative to nominal growth rates then there may be an argument for expanding valuations, or you can take the view that government bond yields are now below the risk-free rate. Lower rates can also inflate asset prices as it drives speculation and carry trades, but this can have a destabilising impact that ends in a crash. We allow for some increase in valuations with falling bond yields and recognise that in a low-growth environment stocks that can deliver earnings growth are more valuable and should trade on higher relative PEs. (Sean Fenton, Portfolio Manager, Tribeca Investment Partners)


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