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  • Mark Beardow

Do low bond yields support high equity valuations?

The consensus is that low rates and bond yields are supporting high equity valuations.

As the chart below shows there is a relationship between high yields and lower valuations (using US data).

At low yields it's more complicated, especially when data before 1970 is included.

In the current regime, low yields have boosted equity valuations. However pre the 70s, low rates sent another signal - an expectation of low real inflation adjusted growth. Which was then incorporated into lower valuations for equities.

Another factor is the growing pool of global retirement savings which may be sustaining higher equity valuations, and depressing future rates of return.

So while, the equity market has seemingly reacted positively to the prospect of modest inflation and growth post covid-19, if this :

1. Results in sustainably higher bond yields then valuations may fall, and

2. If real (inflation adjusted) earnings growth does not emerge then valuations may also fall.

Note the valuation measure here is the Shiller PE ratio which uses 10 year trailing earnings.

Source: Darling Macro, Wellington. For wholesale investors only.


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