Rate Environment — Equity Multiple Pressure

This mechanism is most acute for long-duration equities:

Growth companies whose earnings are weighted toward distant future years are more sensitive to discount rate changes than value companies with near-term cash flows. **Mechanism:

** The simplified Gordon Growth Model expresses this as P/E ≈ 1/(r − g), where r is the discount rate and g is the long-term earnings growth rate.

A 1 percentage point rise in r compresses multiples by a magnitude inversely proportional to the existing spread between r and g.

When interest rates are near zero, even modest rate increases cause large multiple compression because the denominator was already very small.

High-multiple growth stocks (P/E >40x) carry duration risk analogous to long-dated bonds — their valuations are most sensitive to rate moves. **Examples:

** **Example 1:

** 2022 — Federal Reserve hiking cycle:

The Fed raised rates by 450bps in 12 months.

The Nasdaq 100, dominated by high-multiple growth technology companies, fell 33%.

The S&P 500 growth index declined 30% while the S&P 500 value index fell only 5%, illustrating that multiple compression rather than earnings deterioration drove the growth underperformance.

Forward P/E on the Nasdaq compressed from 32x to 20x. **Example 2:

** 2020 — Emergency rate cuts to zero:

The Fed cut rates to 0–0.25% in March 2020.

Despite economic recession, equity multiples expanded dramatically.

The S&P 500 forward P/E expanded from 14x at the March low to 23x by year-end 2020, driving a 68% rally from the low.

Multiple expansion accounted for roughly 80% of the recovery, with earnings contributing minimally. **Thresholds/Conditions:

** Rate changes >50bps in a quarter begin to meaningfully pressure high-multiple stocks (P/E >30x).

Rate changes >100bps in a quarter create broad multiple compression across equities.

The equity risk premium (earnings yield minus 10Y Treasury yield) below 0% historically signals equities are overvalued relative to bonds.