Tags: stock | buyback | companies | rate

Bull Will Ride Until Interest Rates Rise

By    |   Wednesday, 04 Feb 2015 08:16 AM

Low interest rates are making stocks attractive to individual investors and corporate chieftains. Individuals are choosing stocks over fixed-income investments that offer interest rates lower than the rate of inflation in many cases. In this situation, rational investors often prefer to accept the risk of a loss in the stock market to the certainty of a loss in the bond market.

At the corporate level, the decision-making process is a little more complex.

Stock buybacks are up partly because of low interest rates. Buying back shares is a guaranteed way to boost future performance. Lower share counts will increase future earnings per share. If a company can borrow money at a low rate, the accountants will often determine that is the best use of capital. That helps explain why companies have been aggressively buying their own shares in the past few years. According to data from Standard and Poor's, 80 percent of the companies in the S&P 500 have bought back shares in the past year.

Low interest rates also make expansion projects and acquisitions more attractive to management. By increasing their operating capacity, companies should be able to increase earnings in the future. This leads to higher earnings estimates and makes stocks appear more attractive to investors.

In the long run, expanded operating capacity and financial engineering gimmicks like buybacks and mergers could have negative consequences. That's why, in the past, interest rates moved up and down so that the economy could reap the rewards of well-executed projects and eliminate poorly implemented projects.

In recent years, the business cycle has been put on hold by central bankers engaged in unprecedented financial engineering. Until Federal Reserve policy changes, corporate management is incentivized to make low-cost decisions that carry high risk. Once rates rise, we will see which companies made good decisions and which ones destroyed shareholder wealth.

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MichaelCarr
Low interest rates are making stocks attractive to individual investors and corporate chieftains. Individuals are choosing stocks over fixed-income investments that offer interest rates lower than the rate of inflation in many cases.
stock, buyback, companies, rate
307
2015-16-04
Wednesday, 04 Feb 2015 08:16 AM
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