Artificial Inflation of Growth Stocks?

Most people understand that bond prices rise when interest rates decline - and vice versa. (If this is news to you, we need to talk.) Most people also understand that as interest rates have been artificially depressed, bond prices have been artificially inflated.

Too few, however, seem to appreciate that near-zero interest rates have also inflated stock prices.

Even fewer recognize that growth stocks have been the most inflated of all. Why? Because growth stocks’ value is primarily tied to expected cash flows generated very far into the future - just like with a very long-term bond. If you raise the interest rate used to discount these far-away cash flows, the value of the asset declines - perhaps by a lot. Stodgy “value” stocks are less impacted since they generate much more cash in the near term.

Chart of the Week

As you can see above, growth stocks have significantly outperformed value stocks after the Fed depressed interest rates.

Moral of the story: The longer an investment’s time horizon, the more impacted it will be by changes in interest rates. Are you too heavy in long-term investments right at the time that Janet Yellen prepares to lift her heavy foot off of interest rates?

Amen of the Week

“And the more people believe in efficiency, the bigger the bubbles get.”

- Peter Thiel, founder of Pay Pal (from his 2014 book Zero to One)

Yours in the Field,

Frank Byrd, CFA

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