On interest rates

Investment Analysis Clubs Saul’s Investing Discussions
1

I guess that I am of the old school that equates stock values to a cash flow discounted by an interest rate. When the interest rate is increased the present value decreases because of the time value of money. I also believe that the market is buoyed today by the fact that there are few alternatives satisfactory for savers to park cash. Once rates rise, savers will have other alternatives.

Hi again Mike. I’m sure that both of those observations are true. I guess the reason that the market keeps going up (at least for a couple of years) in the face of rising interest rates, is that those headwinds you describe are overwhelmed by companies having increasing profits from the very booming economy which is occasioning the rising interest rates. Just another factor to take into account.

Think of it this way. Everyone expects rising interest rates so there is no surprise factor. Now, if the Fed raises interest rates in Sept by a quarter of a point, from Almost Zero to… Very Close to Almost Zero, do you really think that is going to give savers motivation to pull their money out of stocks to put them in “other alternatives?” And if, six months later, in March, they raise them again by a quarter of a point to Pretty Close to Almost Zero, and the economy is still growing nicely thank you, is that increase in the interest rate going to effect the time value of money enough for people to pay less for companies rapidly growing their earnings? Not me. Not a chance. It will take at least a couple of years of increases, and maybe much more, before the cumulative raise in rates makes bonds competitive with stocks.

Best

Saul

7 Likes
2

“And if, six months later, in March, they raise them again by a quarter of a point to Pretty Close to Almost Zero, and the economy is still growing nicely thank you, is that increase in the interest rate going to effect the time value of money enough for people to pay less for companies rapidly growing their earnings? Not me. Not a chance. It will take at least a couple of years of increases, and maybe much more, before the cumulative raise in rates makes bonds competitive with stocks.” Saul

Brilliant common sense, Saul!

Jim

1 Like
3

This brings me back to the issue of P/E for small cap companies. Last post I used the AA 10-year corporate rate. I should probably have used the A 10-year, but that is still under 3% which equates to a 33 p/e. The value investor could justify buying at 22 p/e, even without exceptional growth.
Even for a forward looking market anticipating higher interest rates, and even thinking 10-year for the bond rate, the market does not seem over priced (to me). Rates won’t go up much unless the economy heats up (barring stagflation scenario). So, I don’t see interest rates as a threat to the growth companies on this board. Threat here is maintaining (or not maintaining) the growth.

KC

1 Like