According to a research report released by UBS, as the U.S. 10-year Treasury yield has risen by about 100 basis points since the start of the year, with a sharp increase of roughly 50 basis points in the past month, the forward 12-month price-to-earnings ratio of the S&P 500 has fallen by 17% since last November.
The bank believes that the valuation has already digested most of the interest rate shock. UBS noted that the magnitude of the P/E ratio decline is already close to the more than 20% level seen during recessions or slowdowns, and is consistent with the valuation decline during the Federal Reserve's rate hike cycle in 1994. Although there are multiple drivers behind the rise in the 10-year yield, the main reason is likely the market's shift from expecting the Fed to cut rates last autumn to currently pricing in more rate hikes, with the 1-year rate one year forward having risen by about 180 basis points since November to December.
UBS stated that although inflation expectations remain elevated, they are still under control. Assuming inflation and employment do not spiral out of control, the Fed's rate hike path is expected to be relatively moderate, and the S&P 500 is more likely to move further upward. Historically, after a sharp rise in interest rates, the S&P 500 has rebounded by an average of 10% over the following year; if the Fed raises rates by no more than 1 percentage point within a year, the average rebound reaches 18%.
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