Exploiting ZIRPonomics in a World
of Ultralow Interest Rates

AllianceBernstein L.P.

We’re living in a world of zero interest-rate policies (ZIRP). Central bank interest rates and market yields are at historical lows in most of the developed world and some of the emerging world. Are you making ZIRPonomics work for you?

ZIRP has influenced the global financial markets in a number of ways. In recent years, as savers and investors have tried to protect themselves from risk, the price premium on “safe haven” assets relative to “risky” assets has increased dramatically. The best illustration of this is the valuation differential between government bonds and equities, which is unusually wide by historical standards.

A simple exercise translating bond yields into the equivalent of price-to-earnings ratios gives us some good perspective on this valuation gap. As shown in the chart below, the S&P 500 Index in the US is selling at roughly 13-times earnings, compared to roughly 60 times for US Treasuries. The valuation gap is even wider in Europe.

The valuation gap between stocks and bonds surfaced during the US housing crisis in 2007 and will, in our view, begin to unwind now that the crisis shows signs of ending. As shown in the chart below, American house sales and prices are turning the corner, potentially opening the way for the bond markets to push mortgage and other interest rates higher. Contrary to conventional wisdom, we believe that rising rates will confirm that housing has turned, and will push prospective home buyers off the fence as they seek to avoid even higher prices and mortgage rates.

We think some areas of the equity market stand to benefit more from ZIRP than others.

1. ZIRP is likely to stimulate growth, so pro-cyclical businesses are one area to watch. The most obvious beneficiaries of economic recovery are cyclical stocks such as the construction companies, the consumer-oriented names and the auto manufacturers.

2. ZIRP is likely to create inflation pressures, so “real” assets—the prices of which are likely to rise along with inflation—are other potential winners. Monetary easing hasn’t led to much inflation pressure so far, partly because banks have not been passing on the full effects of accommodative policy. But, as confidence builds in time, we expect more of an impact to filter through. We are starting to see early signs of inflationary pressures, notably in the US . For example, we are hearing reports of shortages developing in the US auto and building materials sectors. The more resilient types of stocks in an inflation environment are likely to be real-economy plays like oil-field services, gold miners, timber producers and real estate firms.

3. ZIRP has lowered companies’ costs of borrowing, so it’s worth focusing on the businesses that stand to benefit from cheap financing. We think that private-sector investment is on track to take over from government spending as a driver of economic growth. Beneficiaries of this might include industrial companies. Moreover, as labor costs in emerging markets increase, more businesses are automating their production around the world to take back market share. This trend should benefit the Americas disproportionately thanks to the shale oil and gas boom, which is driving relative cost structures even lower. Finally, producers of technology equipment stand to benefit as businesses move to update and upgrade their IT resources to embrace cloud computing.

 

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio-management teams.

Catherine Wood is Head of Thematic Investing at AllianceBernstein.

3 comments

  1. bryan murphy

    well done, would like to hear more

  2. Drew Dimond

    I have read several articles on the same argument comparing stock valuations to the risk free rate of return. The conclusion is that stocks are undervalued based on the gap between earnings ratios and Treasuries. I would be interested to hear opinions regarding if anyone is considering that maybe that it isn”t that stock”s are cheap rather that bonds are expensive. Ten year treasuires last year were around 3.5%, due to monetary policy and most likely European purchasing of US treasuries that bonds yields are artificially low. If treasuries were left to find their equilibrium and rise, and earnings were flat, would that change the valuation metrics used in the article?

    • Catherine Wood

      As you correctly point out, there are two possible ways in which the misvaluation of equities in relation to bonds could be resolved: either through equity prices going up, or through bond prices going down. In reality, we’d expect a combination of both. But we still think equities are likely to do well, in part because the valuation gap is so big. Even if Treasuries moved back to a yield of 3.5%, they would still effectively be valued on a PE of 28 times—twice the price/earnings multiple for the S&P 500 (the historic PE is 13.7 times—the level of PE that we’d be dealing with if earnings remained flat). As the chart in the blog shows, gaps of this size have been rare in the past.

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