Sunday, October 19, 2014

Volatility, low interest rates and stock market valuation

Imagine the case of a stable company that was paying out a 10% dividend each year. If enough people could borrow money cheaply and buy shares in the company, the price of the company would get pushed up, and the effective dividend % would decrease accordingly.

How much of a premium people would want to have to own this company has a lot to do with the volatility of the stock price. If you borrowed money to buy the stock, a big movement could wipe you out before the price has a chance to recover.

Stock prices, until last week had become very stable, which pushed up the valuations.

This is why I’m not very optimistic about short term stock market return. Even if prices went back to where they were last month, someone needs to pay for additional volatility that people forgot was there…

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