Interest Rates and Stock Prices: Looking Under the Hood!

Description
In this video, Professor Aswath Damodaran analyses the relationship between interest rates and stock prices. He argues against the idea that higher interest rates are inherently bad for stocks, suggesting first that fundamentals are the primary reason for changes in interest rates. He then suggests that first, you must make a judgement on why rates are rising before then coming to a conclusion of whether this rise is positive for stock value.

Firstly, Aswath demonstrates how the real drivers of interest rates are in fact economic fundamentals. He suggests that it is not the US Federal Reserve System that drives these interest rates, but instead macro-economic fundamentals. Interest rates, according to Aswath, are driven by two variables: expected inflation and real growth. He demonstrates this in a graph, highlighting that when inflation and real growth are high, so are interest rates. Aswath then demonstrates how the Fed does not lead markets, it simply follows them. As such, instead of watching the Fed, Aswath suggests that you follow inflation and real growth.

Aswath then shows how you can build a valuation based on a consistent narrative. He demonstrates how to assess value for equities depending on assumptions regarding earnings growth, equity risk premiums and risk free rates. He then gives two inconsistent valuation narratives as examples in order to emphasise just how important it is to build your valuation around a consistent narrative.

Aswath analyses the relationship between earnings growth, ERP and T.Bond Rate and how these things work together in affecting inflation.

The bottom line of this video is to reject half-baked market narratives and to develop your own.