Real Rates Drive Stock Prices
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My firm’s Daily Market Commentary provides market insight, analyzes economic and financial news, and highlights a few graphs worthy of discussion. Occasionally, I stumble upon a graph that deserves more than the paragraph or two we typically allot in the commentary. The chart below, courtesy of SoFi and Bloomberg, is one example. It compares real rates and stock valuations.1
The graph presents the inverse relationship between real interest rates and stock valuations. It shows the traditional relationship broke down in October 2022. That divergence and whether it reverts to normal have implications for stock prices and bond yields.
Stock valuations and real rates
Despite a widespread misunderstanding, the dollar price of a stock doesn't tell us how rich or cheap it is. Apple currently trades at around $175 a share. It would trade at about $2.75 trillion if only one share existed. Despite how far apart the two prices are, both prices signify identical value propositions.
Therefore, stock valuations provide a much more genuine gauge of the actual price of a stock.