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Rising Interest Rates May Take A Bite Out of Equities

David Reilly, director of portfolio strategy at Rydex Investments, told CNBC’s “Power Lunch” that rising interest rates may take a bite out of equities in the short-term.

“Clearly, rising interest rates represent a potential threat to equities,” Reilly said Wednesday. “Obviously, we’ve seen a pullback in equity prices over the last few (trading) sessions. With the 10-year treasury at 5%, there’s clearly upward pressure on interest rates.”

But he said the market isn’t yet at the point where the cost of financing derails the liquidity-driven rally.

“One of the things that we think is important is you started to see some multiple expansion,” Reilly said.

“For the past three years, we’ve had stock prices rally basically on the back of earnings," he explained. "But earnings have been accelerating more than prices, so multiples have contracted. Multiples have started to expand a little bit. We think a big function of that is really driven by this global wave of liquidity and those cycles tend to have some legs to them."

"Near term, we could have a little bit more pullback partially driven by the bond market," he continued. "But longer-term, that liquidity – unless interest rates rise significantly – is not going away.”

Howard Rosencrans, chief research analyst at Capital Growth Financial, said private equity is the “singular element” now driving the market.

“It’s certainly not the economy,” Rosencrans said.

“The road toward corporate profits is not going to be nearly as pretty as it has been," Rosencrans said. "You’re having a deceleration in corporate profits, and the economy and the housing bubble bursting is an overriding issue with consumers. It’s the liquidity in the market that is created by private capital as they surge to try to continually take over companies. It’s all being funded by the debt markets and the debt markets are being driven more so by how these bonds have seasoned over the years.”

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