The conventional wisdom among investors suggests that low interest rates are favorable for equities. The assumption holds true with regards to profits and leverage. However, theory tells a different story, as do the performance of two key metrics: earnings yields (how much a company earns per share) and dividend yields (ratio of annual dividend to share price).
In the early 20th century, higher earnings yield was accompanied by pessimistic growth expectations and higher risk premiums. Today, constant and low earnings yield and darkening growth expectations affect equity valuations.
In the U.S. and Japan, earnings and dividend yields were decreasing simultaneously with interest rates. Nevertheless, they climbed up when interest rates reached a historically low territory. This behavior hints at gloomy growth expectations, suggesting investors need to adapt to the challenging environment.
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