This Chart Has the Key to Your Future Stock Market Returns - Chart Of The Day 14 May 2018 - Equitymaster

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This Chart Has the Key to Your Future Stock Market Returns
May 14, 2018

One of the key determinants of liquidity flows in the stock markets is interest rates. The 10-year US Treasury bond is a global interest rate benchmark.

The prolonged artificial suppression of interest rates and money printing by the US Fed, flooded the global financial markets with cheap liquidity and lifted stock prices to frothy levels.

In fact, at the recent shareholder meeting of Berkshire Hathaway, Charlie Munger did make a reference to this condition:

  • Low-interest rates are unfair to old savers, but favourable to Berkshire Hathaway's shareholders sitting here. We are all a bunch of undeserving people and hope we continue to be so.

Now, just the way lower interest rates can fuel stock market rallies, the vice-versa is also true. If interest rates start firming higher, it can play spoilsport to the unbridled global stock market bull run.

In fact, the market correction we witnessed in February-March this year can be attributed to the rising yield on the 10-year US Treasury bond.

In a note to my Insider readers at the end of January 2018, I'd raised a warning flag about the rising yields on the benchmark 10-year US Treasury bonds.

With bond yields now breaching the 3% mark, and the Fed in the process of shrinking its balance sheet, you cannot expect the flood the liquidity to keep lapping up stock prices.

If interest rates go up further, foreign investors will either go slow on India or exit all together.

So, be careful. Don't take the abnormally high valuation multiples as the new normal. At the same time, don't exit the markets out of panic.

Stay invested.

Data Source: FRED Economic Data

This Chart Of The Day was published in The 5 Minute WrapUp - Of Pricey Market Darlings, Rahul's Love Affair with Hated Stocks, and Uncle Sam's Expensive Gift

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