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POSTED BY ON January 7, 2011 4:14 pm COMMENTS (2)
Today the market crashed 2.7% with worry of interest rate hike. I am not a expert in equity but can someone explain how does the increase in interest rate signal worry for equity market?
Do they fear all the money will be pulled out if the interest rates are high? Does the interest rate here refer to the debt interest rate?
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Interesting question. Generally high interest rates has negative correlation with equity returns.
1. If you can earn “risk free” return of 5-10%, why do you want to “risk” your money in equities earning 10-20% or even negative returns.
2. Higher interest rates=less money supply. Consumers spend less and more money goes into repaying loans. Discretionary spending becomes less=less profit for companies.
3. Companies pay higher interest on loans=less profit.
I still favor equities in India for better long term returns and these headwinds just creates more opportunities to buy into quality companies. Typical Indian investor is very very risk averse and act more like a trader when it comes to equity investing, which is a shame really.
Good luck investing.
Disclaimer: I’m not a Market expert or I’m not answering your question in correct. It just my thoughts, based on whatever I understood from your question and around the world.
Market runs over people perceptions, when something happens people thinks bullish or bearish. The market moves according to majority people thinking.
And I guess, current market crash is based up on inflation rate too, that rupee against dollar/euro etc. When value for money decreases companies have to spent more on production ( or so). And when they require money usually they borrows it from banks or financial institutions. So when interest rate goes up, the debts of company increases. Or it affect their profit margins.
So people thinks that companies going have lower profit (or may be loss) in the next quarterly results. And it may affect the share prices. So share prices are going to decline. So it is better to book my profit now, or let me stop my loss.
And regarding banks stocks, when they increase the interest rate, normal scenario it should increase their profit. But there also a chance that less number of firms borrow due to high interest rate, then their profit could get affected.
I think this investor sentiments, affect the market.
PS: I really don’t know why Bank of India & Bank of Baroda went up when all other banks gone down!