The US stock market has reacted positively to the first rate hike by the Fed, and we don’t expect it to be derailed by the onset of further tightening. Admittedly, at around 4%, the cyclically-adjusted earnings yield is low relative to its long-run average. However, it is still nearly 2% points higher than the yield on conventional 10-year US Treasuries, and more than 3% points higher than the real yield on 10-year TIPS, which is arguably a better basis for comparison, given that equities are real assets. This suggests there is plenty of scope for Treasury yields to rise without making the return on equities seem unreasonably low.
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