Higher for longer rates may mean lower for longer stock multiples, and stock prices

As earnings season starts, the biggest concern is not necessarily that earnings will decline. The biggest concern is that investors may not be willing to pay the same amount of money for earnings, even if the actual profits don't change much. When interest rates began declining in November of last year, stocks immediately rallied. Stock prices are based on dividend yields plus an estimate of the rate of annual earnings growth. Earnings estimates did not suddenly rise dramatically.

One reason is that the market comes to believe that earnings estimate is under threat. Let's say investors come to believe that the company will only make 50 cents in the coming year instead of $1. The P/E ratio would then go to 20: $10/0.50=20. The second reason the multiple could change is if investors decided that $10 was too much to pay for $1 in future earnings. Investors might only be willing to pay, say, $8 for that $1 in future earnings.

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