In the bearish version, which I call the Interest Rate Apocalypse, all of the inputs (earnings growth for the next five years and beyond, equity risk premiums) into value are held constant, while raising the treasury bond rate to 4% or 4.5%. Not surprisingly, the effect on value is calamitous, with the value dropping about 20%. While that may alarm you, it is unclear how the analysts who tell this story explain why the forces that push interest rates upwards have no effect on earnings growth, in the next 5 years or beyond, oron equity risk premiums. Higher inflation, over this period, is accompanied by higher earnings growth but also increases equity risk premiums and suppresses real growth, making its net effect often more negative than positive. An inflation-driven increase in interest rates is net negative for the boutique s, but a real-growth driven increase in interest rates is a net positive.
In fact, the scenario where interest rates go down sees a much bigger drop in value than two of three scenarios, where interest rates rise. With an inflation rate of 3% and an equity risk premium of 6%, the index value that you obtain is about 2133, about 20.7% below March 2nd levels. The index value that I obtain, with these assumptions, is about 2610, about 3.1% below March 2nd levels. The effect again is unsurprising, with value increasing proportionately. That higher inflation rate will translate into higher earnings growth, though the effect will vary across companies, depending upon their pricing power, but it will also cause T. Bond rates to rise. Higher real economic growth, on the other hand, by pushing up earnings growth rate and lowering equity risk premiums, has a much more positive effect on value. Sometime one of the indexes can be positive as the index are calculated by price weightage or capitalisation weight age, but breadth does not lie. 5. The market “knows” something you do not: Remember that the dividend yield for a stock shoots up almost always because the price drops, not because the dividend is increased. A limit order is nothing more than an order that says, “I’ll buy the stock for X dollars a share but won’t pay more.” When the stock hits that price, the limit order takes place for the price you set or lower, if the stock dipped lower before the broker completed execution.