Skip Navigation Links
Why is the stock market so high during a pandemic?
28 Sep 2020 (123 views)

The answer is quite simple!

It is due to low interest rate and printing of money by the government. 

Let me quote this example. Suppose the "normal" interest rate is 3% and it has dropped to 1% during the pandemic. The stock price is the EPS (earning per share) divided by the interest rate. 

So, if the interest rate drop from 3% to 1%, the stock price should theoretically increased 3 times! That's right, it is 3 times. 

Even if the earnings drop by 50% during the economic crisis, the stock price can still increase by 50%. 

This is why we have a booming stock market.

What if interest rate drop to 0%? The stock price can go up to the sky! 

However, we should be looking at the long term interest rate, and not the short term interest rate. While the short term interest rate is 0%, the long term interest rate could be 1% or 2% now.

The real risk to the stock market is an increase in the interest rate. If the interest rate increase from 1% to 4%, the stock market will drop by 75%. 

What should a long term investor do? He should avoid buying stocks at the current inflated price. The interest rate cannot remain at such a low level for a long time. 

However, if the PE ratio of a stock is less than 15 times, the risk is small. If the PE ratio if 100 times, it is very risky.

Tan Kin Lian
 


Why is the stock market so high during a pandemic?
[Back] [Print]


The answer is quite simple!

It is due to low interest rate and printing of money by the government. 

Let me quote this example. Suppose the "normal" interest rate is 3% and it has dropped to 1% during the pandemic. The stock price is the EPS (earning per share) divided by the interest rate. 

So, if the interest rate drop from 3% to 1%, the stock price should theoretically increased 3 times! That's right, it is 3 times. 

Even if the earnings drop by 50% during the economic crisis, the stock price can still increase by 50%. 

This is why we have a booming stock market.

What if interest rate drop to 0%? The stock price can go up to the sky! 

However, we should be looking at the long term interest rate, and not the short term interest rate. While the short term interest rate is 0%, the long term interest rate could be 1% or 2% now.

The real risk to the stock market is an increase in the interest rate. If the interest rate increase from 1% to 4%, the stock market will drop by 75%. 

What should a long term investor do? He should avoid buying stocks at the current inflated price. The interest rate cannot remain at such a low level for a long time. 

However, if the PE ratio of a stock is less than 15 times, the risk is small. If the PE ratio if 100 times, it is very risky.

Tan Kin Lian