I have been writing about liquidity glut and low interest rates, and their impact on real economy some time ago. Gerard Minack, the strategist at Morgan Stanley, brings up this issue today and makes it very clear, again:
Exhibit 1 shows the contribution to the 12 month return on US equities from the change in the prospective PE ratio (the PE based on consensus earning forecasts). The amplitude is significant: the swing in the PE often contributed plus or minus 20-30 percentage points to the annual equity return. Importantly, the biggest influence on the PE ratio was interest rates. Falling rates led to a rising PE, and vice versa. (The line in the chart is the 12 month change in the 10 year Treasury yield – but it is inverted: so the line goes up as yields go down.)
Click on chart to enlarge, courtesy of Morgan Stanley.
Well, the times may be changing, as Gerard Minack continues:
This was the basis for the ‘don’t fight the Fed’ mantra. In a credit super cycle – when investors are willing to increase borrowing as rates fall – lower rates are good for risk assets.
A post-bubble environment is different. As I’ve discussed before, macro cycles tend to be weaker and more fragile. As importantly, investors do not respond to lower rates in the same way as they did through the credit super-cycle.
On a days like today it feels like bubble never ended? Some evidence of global stabilisation?