In parts 1-7 of our Cost of Capital series, we discussed our views on inflation and how it would lead to higher interest rates and associated declines in asset prices. Now that this prediction has become reality, we move our discussion to charting a path forward. In Part 8, we highlight the risks and potential outcomes of a Fed tightening cycle pushing the economy into a recession or stagflation period.
About the Cost of Capital Series
Gordian’s Cost of Capital series explores the implications of sea change in capital cost expectations.
After forty years of declining interest rates and minimal inflation, monetary and fiscal stimulus initiatives enacted in 2020 and 2021 flooded the economy with liquidity. This inevitably lead to inflationary pressures that are no longer being described as “transitory”. To contain inflation, interest rates will have to rise. The Fed has already signaled that monetary tightening will occur in 2022. This will have a flow through effect on the cost of capital for businesses and, relatedly, asset prices.
In this vein, Gordian’s Cost of Capital series takes a historic look at the relationship between fiscal/monetary policy, inflation, interest rates and the cost of capital. We then discuss the implications on asset prices (equity and credit) as we enter this new interest rate and inflationary environment.
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In part 7 of our series on the Cost of Capital, we discuss the inflation-related data points market participants need to follow as the US economy enters what is uncharted territory for all but the most seasoned investors. We also highlight certain geopolitical events that could have an impact on inflation and interest rates domestically.
In Part 6 of the Cost of Capital series, we discuss one of the main drivers behind current (and likely future) elevated inflation levels: the cost of labor.
In Part 5 of the Cost of Capital series, we posit that the days of Quantitative Easing and easy money are coming to an end and that the US has reached a turning point on inflation and interest rates. We believe this development will pressure equity valuations and drive widening credit spreads.
In Part 4 of our Cost of Capital series, we take a closer look at the dichotomy between inflation and interest rates. We discuss how easy monetary policy and a “cash is trash” mindset have resulted in a decade of declining credit and equity risk premia. A return to reality in the relationship between inflation and interest rates could have a negative effect on asset valuations.
Part 3 in our Cost of Capital series considers potential monetary and fiscal policies to combat rising inflation and the inequality created by a decade of quantitative easing. The effect on the cost of capital of these policies and the implications for asset prices (both equity and fixed income) will likely be painful for investors.
Part 2 in our Cost of Capital series examines the implications of rising inflation on the cost of capital, including an historic look at equity performance in the 1960s and 1970s. This was a period when high inflation increased the cost of capital and equity returns languished despite improving corporate profitability.
In the first in a series on the cost of capital, Gordian employees discuss the impact US monetary and fiscal policy has had on interest rates and asset prices. We then lay the ground work for how these actions may affect future (i) government policies, (ii) asset valuations and (iii) investment decisions.