But remember, no one rings a bell at bottom nor blows a horn at the top. So what's likely to trigger a real sell off of in the markets? Our best guess is: Bonds, Bonds, Bonds - so how goes the bond market should bring the equities along with them. However, equities appear to be discounting earnings at a 5-6% cap rate with overall PEs hovering near multiples of 18 . Whereas, if the bond markets were expected to hold rates at 2-3%, then PE multiples should be approaching 35 to 40 times earnings. Hmm...
This is an interesting case where the equities are pricing in real inflation and telling us the bond market isn't, and thereby as everyone pretty much knows - overprices the Bonds. The downside on equities should therefore not be as gruesome, unless a much more dramatic move in rates occurs.
Still remember too, that interest rate increases pose a double hazard to stocks as they attack earnings and cap rates, concurrently. Such are the perils of "Valuation Traps" and explain why countries look to debase their currencies in order to hold notional asset values domestically while retaining global trade advantages. Be sure to keep a eye on Japan as they have been trying to find an escape hatch from the trap for more than a decade.
Dr Peter G Kinesa
March 4, 2013