July 29, 2003

Our outlook is fairly straightforward: The economic recovery leads to an increase in earnings. In the short run, the earnings get an additional kick form the increase in aggregate demand caused by the rising interest rates. However, in the face of rising interest rates what happens to market valuations? The answer is fairly straightforward. Bonds have a fixed coupon; hence their value unambiguously declines in this scenario. The issue with equities appears to be ambiguous, both earnings and interest rates increase. At first blush the rise in the denominator (i.e. earnings) and the numerator (i.e. the discount rate) appear to produce an ambiguous result. However, we have argued that since the rising rates are the result of the shift in aggregate demand, the higher interest rate cannot dominate the earnings effect. Domestic asset prices will unequivocally rise. This is a good time to be invested in equities.

You must have an active account to view these reports. You may register for a trial here

Download Complete Report in PDF Format

Download Complete Report in Word Format