Unavoidable Correction Looms as Stocks-Real Yields Divergence Widens
Occasionally, we stumble upon a graph that deserves more than the paragraph or two we typically allot in the Commentary. The chart below, courtesy of SoFi and Bloomberg is one example. It compares real rates and stock valuations.
The graph presents the inverse relationship between real interest rates and stock valuations. It shows the traditional relationship has broken down since October 2022.
The recent divergence and the likelihood it reverts to normal have implications for stock prices and bond yields.
Despite widespread misunderstanding, the dollar price of a stock doesn’t tell us how rich or cheap it is. Apple (NASDAQ:AAPL) currently trades at around $175 a share. It would trade at about $2.75 trillion if only one share existed. Despite how far apart the two prices are, both prices signify the identical value proposition.
Therefore, stock valuations provide a much more genuine gauge of the actual price of a stock.
Coca-Cola (NYSE:KO), for instance, is worth $260 billion.Is it rich, cheap, or fairly valued?
KO’s valuation ratios compare critical fundamental data to its stock price or market cap, allowing investors to assess whether $260 billion is the right price to pay for KO’s future cash flows.
Real interest rates, the current interest rate less inflation or the expected inflation rate, perform a similar task for bonds. Is an 8% bond yield rich or cheap?
The yield level is meaningless without an appreciation for inflation, economic growth trends, and Fed policies. 8% may sound fantastic, but would you think so if inflation ran at 12% and was expected to remain in double digits for a decade?
Low or negative real rates are economically stimulative as the incentive for people and companies to borrow and spend or
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