The conventional wisdom in the investment world is that rising interest rates automatically lead to a compression of equity multiples. However, JPM’s historical analysis challenges this notion, suggesting that strong earnings growth can actually absorb higher yields without putting valuations under pressure. With consensus EPS growth above 20%, the S&P 500 may be able to tolerate 10-year yields closer to 5.5-6%. The key variable is no longer just rates, but rather the ability of earnings to keep delivering growth.

To understand why this is the case, it’s important to look at the historical relationship between yields and equity multiples. Traditionally, as yields rise, the multiple of earnings required to sustain the same level of stock prices declines. This makes sense, as investors demand higher yields to compensate for the increased cost of borrowing. However, JPM’s analysis shows that this relationship has broken down in recent years, with earnings growth playing a more significant role in determining equity valuations.

The reason for this shift is the changing nature of corporate profits. With the global economy growing at a slower pace and inflation remaining subdued, earnings growth has slowed but not collapsed. As a result, companies are able to maintain their profitability even as yields rise, providing a cushion against higher borrowing costs. This cushion can absorb higher yields without putting valuations under pressure, as long as earnings growth remains robust.

Of course, this analysis is not without its limitations. The current environment of low inflation and slow economic growth may not be sustainable in the long term, and a pickup in inflation or a more robust economic expansion could lead to a reversion to the historical relationship between yields and equity multiples. Additionally, there are other factors that can impact equity valuations, such as changes in investor sentiment and the overall economic environment.

Despite these caveats, JPM’s analysis suggests that the traditional relationship between yields and equity multiples may not hold true in the current environment. With earnings growth remaining strong, the S&P 500 may be able to absorb higher yields without a significant decline in valuations. As always, investors should remain vigilant and adapt their strategies as market conditions evolve.