Traders,

One of the simplest ways to explain why the stock market is cratering is with the so-called discount rate. Fundamental analysts say a company is worth all future cash flows discounted back to the present value. In other words, how much investors are willing to pay for Apple isn’t only a function of how much the technology behemoth makes today. It’s also a matter of how much money they’re going to make in the future.

How we value those future earnings depends largely on the current level of interest rates.

• If interest rates are high, then future earnings are worth less.
• If interest rates are low, then future earnings are worth more.

To use an extreme example, imagine interest rates are at 50%. In that world, $1 of earnings today is worth $1.50 of earnings in one year. The gap between the two would grow exponentially as you move out further in time, making future profits worth way less.

On the other extreme, if interest rates are 0%, then $1 of earnings today is identical to $1 of earnings in 5, 10, or even 100 years. In that world, future earnings are worth the same as those today. The actions of the Federal Reserve quickly have the discount rate ballooning. And with that, the value of future earnings are cratering. Stocks are being repriced accordingly.

Video Of The Day: How to open an Option Chart on Thinkorswim

Coach Tim explains how to open and analyze an #option chart on #thinkorswim.

Chart of the Day: S&P 500 P/E vs. Rates

This chart is using Real 10-year Treasury yields as a proxy for the discount rate and it’s inverting them. Thus the light blue line falling is a reflection of rising interest rates. Note how correlated the P/E ratio of the S&P 500 is to the movement in interest rates.

Options Theory Blog

How Bonds Work

Today’s video explains why bonds and interest rates move in opposite directions.

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