Why low-interest rates are both good and bad for the stock market
July 27, 2020
Stock market and low-interest rates
With the US interest rates at historic lows, and intention by the Fed to keep the fed fund rate near the zero levels until the negative impacts of the coronavirus have passed, probably for at least 2021, the US stock market could benefit and rise even more. But what risks lie ahead for stocks?
Low-interest rates could boost stocks but high debt remains a concern
With low-interest rates investors and traders have turned to stocks for higher risk-adjusted returns. In terms of valuation low-interest rates are positive as they are associated with the risk premium that is used to value the future value or intrinsic value of stocks. Now the current 10-yr bond yield is about 0.60%. and the 30-yr bond yield is about 1.23%. With very low interest rates for deposits a shift of capital into stocks, is a key factor for the rally of the US stock market after the crash caused by the coronavirus pandemic in March 2020.
But high levels of debt for companies even at low-interest rates should not be neglected by investors. Stocks with increased debt ratios are high risk stocks, as any decline in the operational cash flows may make the repayment of debt unsustainable, and could lead to default.
Another factor is that at low-interest levels companies may use excessive debt without taking into consideration that at some point in time interest rates may probably start raising again. And this may hurt not only their profitability but their financial performance and existence as well. Investing should always analyze the debt levels of companies for stocks to invest in or stocks to sell.
Debt can be good or bad for stocks, it depends on its use and its level