DataTrek’s Colas challenges view that rising rates automatically crush equity valuations
Nick Colas argues that isolating interest rates in valuation models ignores the compounding effect of corporate earnings, citing data where P/E ratios expanded despite a doubling of the 10-year Treasury yield.
Nick Colas, co-founder of DataTrek Research, has challenged the conventional market narrative that rising long-term interest rates inevitably lead to lower stock valuations. In a note to clients on Wednesday, Colas argued that the correlation between higher yields and declining equity multiples is an oversimplification that fails to account for the impact of earnings growth expectations.
Colas pointed to historical data to illustrate the divergence from standard discounted cash flow assumptions. Between 2015 and 2019, the 10-year US Treasury yield averaged 2.27 per cent, while the S&P 500’s forward price-to-earnings (P/E) ratio remained between 15x and 18x. As of Wednesday, the 10-year yield had risen to 4.49 per cent, yet the S&P 500’s forward P/E ratio had increased to 21x.
The analysis suggests that equity valuations are not solely determined by the cost of capital. Colas explained that if interest rates rise by two percentage points but earnings growth expectations increase by three per cent, equity valuations can still rise. This highlights a mechanism where fundamental corporate performance can outpace the drag of higher borrowing costs.
Colas warned investors against what he described as the errors of short-sighted market prognosticators. He noted that many analysts adjust one variable in a complex formula while holding all others constant, a practice that does not reflect real-world market dynamics. In reality, variables such as earnings, tax rates, and energy prices move simultaneously, often providing theoretical justification for market moves that appear counterintuitive in isolation.
The observation serves as a reminder that markets are complex systems where single metrics rarely tell the whole story. While rising rates are theoretically negative for valuations if earnings remain static, the historical trend of rising corporate earnings has allowed multiples to expand even as yields climbed. Investors are urged to consider the broader macroeconomic crosscurrents rather than drawing conclusions based on isolated data points.
