The post-Lehman period is interesting for two reasons. One, the technology eco-system (semiconductors, e-commerce, hardware (smartphones etc.), software, cloud etc.) compounded into becoming the most dominant segment in the equity market. Second, central banks have constantly pushed down interest rates despite the temporary period for the Fed in the years 2016-2019. Technology companies have lower capital expenditures requirements relative to revenue growth and the digitalization from a low penetration created a high growth environment for these companies with high operating margins and predictable cash flows.
As the interest rates have come down the valuation multiples on these types of businesses have increased dramatically and with long USD rates getting very close to zero the multiplication effect goes exponentially. On top of this the technology companies have delivered growth in free cash flows beyond the growth rate in the pre-Lehman period and the combination of the two has created a period (post-Lehman) where S&P 500 has delivered annualized return of 11.4% compared to only 5.3% annualized for US 10-year Treasuries. Despite this massive outperformance US equities still look attractive relative to US government bonds but relative to itself measured against the pre-Lehman period. The critical assumption behind this is the Fed will keep interest rates at these very low levels for a very long time. This assumption will come under massive pressure if inflation comes back but given our little understanding of forecasting inflation it will difficult to know when to change the mindset on equities. But our advice to investors is to closely monitor the US 10-year yield and inflation expectations.