Inflation Shocks & Real Rate Reset: What is pulling the lever on Equity Valuations (2021-2025)

For this analysis, Core PCE YoY percentage, 10Y TIPS, and S&P 500 E/P from trailing 12-month earnings were used to fundamentally understand the driving forces between equity valuations and the corresponding economic landscape from January 1st 2021 - November 1st 2025. During this period, equity valuations inhibited a full cycle, from 2022’s compression to a then re-expansion into 2025. To present a multifaceted answer, it’s important to understand how these variables connect specifically with valuation metrics statistically, to answer investor questions of: What happened? What is forcing the valuation channel? Read in unison these metrics show a clear sequence.

In 2022 as inflation began its surge earnings-yield saw elevation amidst a market re-price, as real yields moved from negative into the positive realm, investors demanded greater compensation for risk and thus trailing PE ratios began a compression phase. Then as disinflation took hold, valuations regained momentum even amidst elevated real yields. To keep the analysis clean, four simple visuals were added to unpack the relationship of these metric’s data. Firstly a time series analysis of Core PCE and earnings-yield across the period of 2021 - 2025 (Figure 1) frames how the market’s required yield for equities rose amidst rising inflation and eased as inflation cooled. Figure 2, compares S&P 500 trailing earnings-yield against the 10Y Real Yield (TIPS rate), showing as real yields crept into the positive, valuations began their 2022 compression. Figures 3 and 4 show the correlated slope between Core PCE and Real Yields as measured against earnings-yield.

Regime 1 – (2021): Negative Real Yields, Rising Inflation, Elevated Earnings-Yield

The 2021 economic outlook in hindsight operated as a regime which greatly supported equity multiple valuations. Firstly with real yields negative as inflation began its rise, the demand for equities increased. However, it’s important to also note, a rising core PCE is not a stand alone variable plugged into DCF models, rather what's impactful is how inflation changes affect the expected Fed policy trajectory, and how much investors expect to earn while invested in safe assets. In 2021, with real yields negative, the attraction to safe haven assets was simply not as material compared to the opportunity cost of more speculative assets such as equities. With risk free inflationary protected treasuries yielding a negative return, equities didn't even necessarily need to present exuberant earnings-yield. This structural occurrence can be viewed in Figure 2, as earnings-yields remain compressed during the period of negative TIPS returns, while their valuations remain high, making each dollar paid for earnings more expensive. In Figure 1, as inflation begins its rise from 2021 through 2022, earnings-yield were consequentially driven higher and their P/E ratio compressed, however the rise is not proportional to the severity of inflation's acceleration.

Conceptually, this is the market treating the inflation rise as potentially temporary with a corresponding accommodating Fed policy. While the rationale becomes, yes, inflation may be increasing, but the real discount-rate anchor hasn't yet shifted. This culminates in a market where valuations remain elevated despite a heating inflation, until forecasters and investors become convinced the accelerating inflation path has indicated itself to be persistent enough that policy response is necessary. 

Regime 2 – (2022): Persistent Inflation, Rising Real Yields, Compressed Valuations:

Both Figure 1 and Figure 2, exemplify 2022’s market re-price, while investors expect the inflationary trajectory to be consistent enough to force monetary policy. Thus the yield curve reprices upward to be in unison with the expected path of interest rates and inflation compensation. Such can be noticed in Figure 2, as real yields climb from negative to positive across 2022, while in turn a correlated equity discount rate increases. The market re-price forces higher discount rates onto equities, decreases the present value of future cash flows, and in turn the equity price drops faster than trailing earnings adjust. All while the market demands a higher required yield on equities, so earnings-yield jumps.

Specific Months of Note: (Values are end-of-month and based on works cited data)

• Dec 2021: Core PCE 4.96%, 10Y TIPS -0.99%, Earnings Yield 4.15% (P/E 24.09x)

• Jan 2022: Core PCE 5.09%, 10Y TIPS -0.69%, Earnings Yield 4.38% (P/E 22.82x)

• May 2022 (first month TIPS turns positive): Core PCE 4.93%, 10Y TIPS +0.21%, Earnings Yield 4.65% (P/E 21.49x)

• Jun 2022: 10Y TIPS +0.53%, Earnings Yield 5.08% (P/E 19.69x)

• Sep 2022 (valuation trough / yield peak): Core PCE 5.31%, 10Y TIPS +1.14%, Earnings Yield 5.22% (P/E 19.17x)

• Oct 2022 (TIPS peak): 10Y TIPS +1.59% while Earnings Yield falls back to 4.46% (P/E 22.41x)

• Dec 2022: Core PCE cools to 4.73%, 10Y TIPS +1.36%, Earnings Yield 4.50% (P/E 22.23x)

  
  

Mechanically across 2022, real rates begin to price in an adjusted gauge of required return based on real policy rates and term premium, even before inflation was too visibly cool. Earnings-yield jumped as inflation rose due to prices falling faster than trailing earnings moved, per the data 2022 saw a year of market repricing on the discount rate and risk premium quickly. The scatter plots Figure 3 and 4, captures why 2022 feels as if a “repricing event” rather than simply inflationary noise. Higher inflation increases uncertainty, and as the required yield demanded by investors increases, as seen across Figure 3, the PE ratio compression clusters around high-inflation months.

However, it's important to note that while equity earnings-yields and inflation show a positively correlated slope across this study, it is a relationship which lacks stability month to month. Meanwhile the earnings-yield vs TIPS scatter plot, Figure 4, is looser, which is an important signal in itself. This suggests real yields are not a singular variable explanation for valuations MoM change instead they function as drivers of constraint. Positive real yields as seen in Figure 4, equity valuations have to clear a higher bar, with the market repricing to meet it. 2022 serves as the moment rising inflation had clear impacts towards driving policy.

Regime 3 – (2023 - 2025): Disinflation, Positive Real Yields, Valuation Expansion

After the 2022 repricing, one would believe if real yields stay positive that equity market valuations would remain constrained with earnings-yield remaining elevated. However, in 2023 as the Fed’s preferred inflation tracker, Core PCE, trended downward the 10-year TIPS remained structurally positive and continued with momentum, rather than collapsing back downward. In reality, this period saw earnings-yield drift downward and inversely PE ratios re-expanded. This whiplash phase occurs after the market sharply repriced in 2022 and valuations rebuilt without a full reversal in the real-rate regime.

When looking at earnings-yield vs Core PCE time series, Figure 1, as inflation cools the market no longer requires the same inflation-risk compensation which was embedded in the shock and earnings-yield eases. Meanwhile in earnings-yield vs TIPS timeseries, Figure 2, even with the higher real discount rate, equities can re-rate if the market overall holds confidence about future growth paths. This “confidence” can come through several mechanisms, reduced recession probability, stabilizing margins and earnings expectations, or a declining ERP. It’s interesting to visualize that while real yields may set the floor the equity market still moves on the spread investors require over such floor, divulging into risk appetite and growth expectations after the inflationary shock.

Figures 3 and 4, reinforce why 2023 - 2025 equity valuations behave differently. In Figure 3, 2022’s peak points of both high inflation and earnings-yield are digestible, as Core PCE moderates, earnings-yeild becomes lower consistent with viewing inflation as a shock variable. In Figure 4, the data remains dispersed without a common trend with positive real yields corresponding to a range of equity valuations depending on what investors believe about forward earnings and risk. The dispersion suggest the market is not trading on a single macro variable, it's trading between the changing balance of high real-rate floors and an improving risk and growth narrative. 

Figure 1

Figure 2

Figure 3

Figure 4

Works Cited (MLA 9)

---

Board of Governors of the Federal Reserve System. “Market Yield on U.S. Treasury Securities at 10-Year Constant Maturity, Quoted on an Investment Basis, Inflation-Indexed (DFII10).” FRED, Federal Reserve Bank of St. Louis, updated 30 Jan.

2026, https://fred.stlouisfed.org/series/DFII10. Accessed 1 Feb. 2026.

Bureau of Economic Analysis. “Personal Consumption Expenditures Price Index, Excluding Food and Energy.” Bureau of Economic Analysis, U.S. Department of Commerce, last modified 22 Jan. 2026, https://www.bea.gov/data/personal-consumption-expenditures-price-index-excluding-food-and-energy. Accessed 1 Feb. 2026.

“S&P 500 Earnings Yield.” Multpl, https://www.multpl.com/s-p-500-earnings-yield. Accessed 1 Feb. 2026.

“The S&P 500 Isn’t That Expensive. Look at Profit Margins.” Barron's, 17 July 2025, https://www.barrons.com/articles/sp-500-earnings-profit-margins-bd97d74b. Accessed 1 Feb. 2026.