Central Bank Policy — Index Multiple Regime

Central banks became the dominant force in equity markets in the post-2008 era.

Through quantitative easing, zero interest rate policy, and forward guidance, major central banks transformed the backdrop for index valuation multiples in ways that fundamentally altered the relationship between earnings growth and index price performance.

The mechanism operates through the discount rate embedded in equity valuation.

When central banks suppress interest rates via QE, the risk-free rate used to discount future earnings falls, mathematically justifying higher P/E multiples.

Lower rates also push investors along the risk curve — bonds yield less, so equities must be valued at higher multiples to compete for capital allocation.

Fed balance sheet expansion directly correlates with index P/E because it simultaneously suppresses discount rates and pushes capital into equities. **Example 1:

• to 26x (December
• even as underlying earnings growth remained moderate.

Index rallied 115% from trough. **Example 2:

** 2022 — Fed QT cycle:

Fed began quantitative tightening at $95B/month pace while hiking rates 425bps → forward P/E compressed from 26x to 17x by year-end.

The multiple compression alone drove ~25% of the index decline even before earnings cuts.

Thresholds:

Fed balance sheet above $9T = historically expensive multiples likely; rate hike cycle start = multiple compression begins within 2-3 quarters; balance sheet shrinking >$100B/month = structural headwind for index-level valuations.