Here’s an idea: Equities have already priced in the drag from a higher cost of debt.

One pillar of cautious commentary around the prospects for stocks is the notion that eventually, higher rates will bite corporates.

Last year, the largest US companies were insulated from higher borrowing costs by the aggressive terming out of debt profiles in 2020 and 2021. (If only Treasury had done the same.)

This is a familiar tale. Creditworthy corporate heavyweights amassed sizable cash piles at very favorable fixed rates, and that cash not only served to shield companies from the largest YoY jump in borrow cost in two decades, it also began to throw off meaningful interest income as rates increased. Some companies thus became beneficiaries of higher rates.

Although most market participants are well apprised of this dynamic by now, it’s worth highlighting the figures below from BofA’s year-ahead US equity outlook.

More than three quarters of S&P 500 debt is long-term, fixed. That figure is much higher than it stood prior to the financial crisis.

The figure on the right (above) is almost a cliché by now. Small-caps have a (frighteningly in the current context) steep maturity wall. Just 60% of Russell 2000 debt is long-term fixed.

So, what about the impact of higher rates? So far, the effective interest rate for the S&P 500 is barely higher, where that means just now approaching pre-pandemic levels, which were anyway the lowest in modern history.

According to BofA’s Savita Subramanian, the margin impact from higher interest expense is negligible. “Companies are generating much higher interest income from their cash balance, mitigating the impact,” she wrote.

Coming quickly full circle, Subramanian said that if you assume the cost of debt is 7% through 2028, the cumulative impact to S&P 500 EPS is just -6% over five years, or -1% annualized.

That’s already in the price, she suggested: “A 20% drop in the fwd P/E more than prices in the risk, in our view.”