How can stock markets fly so high when the economy is in its deepest dip in 90 years? This widely noticed disconnect has led to speculation about impending market crash, with dreadful consequences for pension plans and individual investors. But maybe the stock market isn’t so crazy as it might seem.
But this analysis is incomplete. It fails to take into account the impact of interest rates on market valuations. With U.S. and Canadian 10-year bond yields at 0.66 per cent and 0.54 per cent, respectively, interest rates not only are very low but they have also sharply declined in the past 12 months — by 71 per cent and 64 per cent, respectively.
Suppose a number of important companies do go bankrupt or are acquired by stronger rivals. In most industries, this will mean less competition and more pricing power for the companies left standing. Companies that can scale up their production will generate more profits, maybe even to such an extent that industry profits will be higher than they would have been with more firms competing.
A final point: stock markets arguably hate uncertainty but there is now much less uncertainty about COVID-19 than there was a couple of months ago. We better understand both how the virus is transmitted and its effects on infected individuals. The virus also appears less deadly than once believed, with the latest estimates of the infection fatality rate falling between 0.1 per cent and 0.
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