Olga Bitel: That economic growth this year is likely to be strongest in decades is becoming increasingly a consensus view. The implications of this robust growth though are still being hotly debated. Specifically, we see rising nominal bond yields and downward pressure on PE multiples as completely consistent with the Goldilocks scenario of rapid economic growth and tame inflation. Let me discuss each in turn. In the fixed income markets, yields on 10-year treasuries have moved up sharply in just two months much to the surprise and the expectations of many fixed income investors. So far, the debate has focused on rising inflation as the byproduct of what is now largely expected very rapid economic growth this year. But historical evidence of the past seven decades suggests that rising 10-year yields are a function of the increase in the nominal GDP growth. The fact that real economic activity is expected to accelerate substantially argues for nominal yields rising in our view, even if inflation does not accelerate beyond the 2%-3% range. Now, let’s turn to equities. Accelerating economic growth and the accompanying rise in nominal interest rates depresses PE multiples overall and reduces the wedge in multiples between the fastest growing companies and everyone else. Rising interest rates act to reduce the net present value of future earnings of all companies, while rapidly rising GDP means that growth is more abundant, and this reduces the scarcity premium portion of the multiple of the very best growers. Stock markets rise in periods of accelerating growth, but this year much of the increase in stock prices is likely to come from rapidly growing earnings instead of expanding PE multiples, as was the case last year.
2020 was mostly about expanding PE multiples, consistent with the early stages of economic recovery. And we expect 2021 to be all about earnings growth well in excess of expectations in many cases and this, too, would be consistent with prior experience during economic expansions.