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« ETF Update: Searching for Oil | Main | Who is Overconfident? »

February 10, 2010


ron glandt

I believe the Feds want to crank-up some inflation prior to increasing interest rates.

With real estate, increased interest rates eventually depress prices, depending on the level of inflation, because the higher interest rates add expense. I would expect there is an interest rate level that the result is the same for stocks unless there is also a degree of inflation

Ron Glandt


Ron -- PE ratios are above average if you look backward (including a lot of one-time write downs) and also if you ignore interest rates.

Anyone who does valuation without paying any attention to interest rates is missing a big part of the story, IMHO.

But you certainly are asking the question on the lips of many.




Greg -- I am delighted that you clicked through to the old article. I spent a lot of time on that one, and I am prepared to defend the conclusions.

The 100-1 concept was supposed to be illustrative -- an extreme example showing that the relationship was not linear. That is clearly the result of my data analysis. The other authors on this topic just "throw out" data that does not fit their method.

I am comfortable with using the regression results in the article. The point is that investors should not panic when short-term rates start to move higher.

As to duration -- this is an empirical question. Like many such questions with stocks we just do not have enough data to be sure. Meanwhile, the current market valuation is so far off that the point you raise is really quite academic.

I really appreciate your careful look at this. Feel free to come back or to give me a call to discuss.



ron glandt

Aren't PE ratios already above average? I read recently that the PE ratio of a stock is not an indicator of a stock to rise or fall.??

Greg Pribyl

Your post conflates two interest rates: Fed Funds and the ten year Treasury. The Fed Model uses the 10 year, not Fed Funds.
You stated "The main point is that when interest rates are extremely low, the "Fed model" approach breaks down. No one believes that an interest rate of 1% implies a stock P/E of 100. When rates get too low, it is a sign of danger."

But the Fed Model has never been applied to 'interest rates' of 1%. In the regressions in your own 2007 posts, 3% (10Yr) is the lower bound.
So your quote above is moot and unsupported by any data.

Most important, you said "As interest rates move higher, it is a sign of strength. It will signal P/E multiple expansion."
That is clearly false, as shown by your own regressions in the 2007 posts on this blog.

Do you believe that a discount rate (10yr T, or whatever) is not an appropriate factor in stock valuation?

There are numerous studies showing that stocks' duration is greater that the 10yr Treasury.
Do you now think that your 2007 regressions and these studies all have some fundamental flaw?


Once again, Jeff, the rational approach is proven to be the most obvious, yet the most easily forgotten. Thanks for the reminder about interest rates. If ever we had a ton of time to bake in expectations for rising interest rates, it's now.
from yourpaldal


Jeff - always enjoy reading your posts. I had an interesting experience last year: almost deleted your blog from my feed when your views opposed mine too strongly (I had a bearish outlook). I then recognized my confirmation bias and fortunately did not. Thank you.


Amber Guity

Yes that has been my understanding or put this way PE ratios reflect demand for that issue- higher earnings momentum growth stocks average 45 PEs while big DOW s&p low ones but you make sense because at extreme low interest rates are also low since the economy is such there isnt even any demand for money to invest- in what there isnt a future whereas the PE expansions reflect confidence in future earnings are back in view.

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