They do, but the biggest way this happens is investors shifting their asset allocations into bonds. So if bonds pay 10% per year a company with a p/e of 30 looks less attractive than if bonds pay 3% per year.
> They do, but the biggest way this happens is investors shifting their asset allocations into bonds.
The opposite is true actually, when rates go up there is a sell-off in bonds which is exactly what is happening right now where bond prices are down 10%-20%
You're saying if interest rates increased and stock price P/E remained the same most funds would allocate less money to bonds?
I don't understand why that would be. If the expected future cash flow of one asset increases (bonds), and remains the same for another (stocks) why would you allocate more money to stocks and away from bonds?
The future cash flow of existing bonds is fixed and it does not increase. If you have a bond that pays a 2% annual coupon you will see it's value drop when interest rates increase. The reason is that you can now get a newly issued bond that pays a higher (say 3%) fixed coupon so your's is worth less.
Your bond's price will drop to say 90% of the notional amount while the new bond will trade at 100% so they will effectively have the same "yield" of 3%.
The future cash flow of any given bond stays the same. But from an asset allocators point of view the cost of the future cash flow from a band decreased, making it a more attractive investment.
You're describing the same thing from different perspectives.
Bond prices are down, this means yields grow, and thus become more attractive investments than high P/E stocks.
I think the reason this sounds unintuitive is because the bond market isn't exactly a "free market" in the general sense. The Fed is manipulating the money market to set bond yields, so from a causative point of view, the yields rise first, which cause a drop in bond prices, which make buying bonds attractive for investors, who then, as a result, shift assets from stocks to bonds.
(disclaimer: just speaking from knowledge gleaned from, among all things, youtube videos :D definitely not an economist !)