2 + 2 still equals 4.
That’s the rough math behind a bullish argument for stocks outlined by Jonathan Golub of Credit Suisse, the chief US equity strategist, in a client note Monday.
To illustrate his point, Golub took the largest BBB tranche of US companies with investment-grade credit ratings and outlined why current bond spreads of 2.2%, plus the yield of about 2.1% on 10-year Treasury TMUBMUSD10Y,
interest rates, still driving historically low financing costs of 4.4%, (see chart) a positive point for equity valuations.
Golub compared two other dates in the past 25 years when stock multiples, calculated as a price-to-earnings ratio, were 19.2x. In May 2002 and July 1997, financing costs were approximately 8%.
That cost includes the spread, or premium over the risk-free rate, which helps investors compensate for default risks. BBB corporate bond spreads rose to about 2% in March from about 1% in 2021, plus Treasury yields.
In short, most publicly traded companies can still borrow at historically low costs, even though the Federal Reserve started raising benchmark rates last week for the first time since 2018, as it envisioned a series of further hikes.
“Surprisingly, the cost of capital today is dramatically lower than in these comparable periods, supporting the argument that equities are valued more attractively today,” Golub wrote.
More broadly, the Credit Suisse strategist also expects monetary policy to remain “too accommodative” relative to the pace of economic growth, a backdrop he sees as favorable for stock prices.
Federal Reserve chairman Jerome Powell on Monday did not rule out the possibility of raising Federal Funds interest rates in increments of more than 25 basis points this year to tackle inflation at its 40-year high, in comments to the Federal Reserve. National Association for Business Economics.
Shares fell after Powell’s comments, giving up on previous gains, with the Dow Jones Industrial Average DJIA,
with over 300 points and the S&P 500 index SPX,
down about 0.7%, despite the energy component rising 3.5% as US oil prices CL00,
climbed to $110 a barrel.