The strong inverse relationship between P/E ratios and changes in the Consumer Price Index can be directly traced to investors' required rate of return.

Question

Quizplus · Accepted Answer

Investors' required rate of return is influenced by inflation, and changes in the Consumer Price Index reflect inflation. When inflation is high, investors demand a higher rate of return to compensate for the decrease in purchasing power of future cash flows. This results in lower P/E ratios. Conversely, when inflation is low, investors are willing to accept a lower rate of return, resulting in higher P/E ratios. Therefore, there is a strong inverse relationship between P/E ratios and changes in the Consumer Price Index.

The Strong Inverse Relationship Between P/E Ratios and Changes in the Consumer