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The impact of inflation and interest rates on companies’ price to earnings ratios

The impact of inflation and interest rates on companies’ price to earnings ratios

Currently-surging US inflation has triggered a dramatic move in interest rate expectations, which in turn have inspired equity investors to reassess the risk they are willing to adopt. In the space of seven months, US short-term interest rate expectations have moved materially.

Back in July last year, the US Federal Funds rate was expected to be 0.3 per cent by the end of calendar 2022. Today, the rate at that time is expected to be 1.25 per cent.  And the old 0.3 per cent target is now expected to be exceeded in a matter of weeks.

The shift in sentiment to higher rates and sooner has been dramatic.  And the repercussions for equity investors have been impossible to ignore. The simple fact is, for the last four decades, whenever inflation or interest rates have risen, the multiple of earnings investors have been willing to pay for a share in a company has declined. In every one of the seven phases US 2-Year Treasury yields rose between 1980 and today, the US S&P500 12-month forward PE Ratio declined.

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Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.

This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.

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