What inflation and interest rate conditions are associated with equities being attractive?

• A. Higher inflation
• B. Lower inflation and lower interest rates
• C. Higher interest rates with low inflation
• D. Inflation variable

Answer: (B)

Equities look most attractive when inflation is low and interest rates are low, because the value of future profits is more favorable and borrowing costs are cheaper. Low inflation brings steadier margins and clearer earnings growth, reducing the pressure from rising costs. When inflation remains contained, central banks can keep policy rates low, which lowers the discount rate used to value future cash flows. A smaller discount rate increases the present value of those profits, supporting higher stock valuations. Cheaper debt also boosts corporate investment and earnings potential, while bonds become less attractive relative to equities, tightening demand for equities and often pushing up prices. In contrast, high inflation tends to push rates higher and create uncertainty about future profits, which raises discount rates and can compress valuations. An environment with inflation that’s volatile or rising alongside higher rates generally weighs on equity attractiveness.