There's a theoretical link between interest rates and price/earnings multiples. It is generally believed that higher rates lead to lower multiples and vice versa. ConvergEx recently pointed out that it's been a 30-year bull market in bonds and hence interest rates are at incredibly low levels. At the same time, multiples have not expanded.
The most obvious reason is that equity investors fear growth and so put a low multiple on expected future growth. This might be a good time to go back and look at "The Trouble with Earnings and Price/Earnings Multiples" by Rappaport and Mauboussin. The market is watching economic reports, political speeches and company management guidance for signals about future growth.
Setting all theories aside, the fact is that there are trillions of dollars in assets that need to be in something. Money flow will be the reason that the stock market recovers ahead of any fundamental signs.
As yields begin to look like they can't get lower (some banks are now charging interest on large deposits), the relative earnings yield of the equity market begins to look irresistible. It's the only practical way to shift huge volumes of assets into another investment class with attractive income and room for capital appreciation.
So what should you do? Right now most people are avoiding the equity market, but with yields this low, it's time to load up on the largest, most liquid and cash flow generating stocks. We only cover technology so the large cap names that look the best are Cisco (NASDAQ:CSCO), IBM, Apple (NASDAQ:AAPL), Microsoft (NASDAQ:MSFT) and Dell (NASDAQ:DELL). These are the kind of names that will go up first.
Beyond that, there are many names in the small and middle capitalization range that will tend to follow the large cap move. We're looking at a small IT security company called Intersections (NASDAQ:INTX) that looks very cheap and has a real dividend. It's clear there are dozens out there like this one that are now on sale at a major discount.
Once the money flow starts to shift into these large attractive equity names, it will generate strong six month returns. After that, we need to see GDP growth confirm which will drive IT spending growth on a six month lag. It's a strong argument for owning these names in 2011.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.