08 August 2014

STI Below 3,300 Point - 8 August 2014

As of afternoon today, the STI index is going back to the level below 3,300. It seems that 3,300 is the strong resistance level for STI index now. With US stock market dropped due to Iraq tension, I believe that it could be a short term impact to the market. The key point is whether the stock market could still perform well after the US interest rate increased later.

If we look at the conventional financial term, the interest rate is regarded as risk free rate, as the investors could put their excess cash in fixed deposits at theoretical zero risk. They would invest their excess cash if and only if the return rate is higher than the fixed deposit rate.

The equity risk premium is regarded as the additional required return rate apart from risk free rate. If risk free rate is increased, the equity risk premium is increased as well. The reason why the stock market perform better during increasing interest rate environment (when equity risk premium is increased) could be:

  1. Overall economy are doing well, there are more investors willing to reduce their own target return rate during the good time, as they do not wish to miss the boat.
  2. Increase in interest rate normally may increase inflation rate, as businessmen may pass down part of the additional borrowing cost to the end users. When inflation rate increases, the investors may think that the return in FD (risk free rate investment tool) may not beat inflation, and they are forced to seek additional income by investing in higher risk investment.
  3. When interest rate is rising, the banks may face issues in lending out the money to the borrowers. They may in turn loosen the lending rule by lending it to less qualified borrowers and cause the bubble in bank lending and some of the money may flow into stock market.
Nonetheless, as long as we have long enough investment time horizon, and we are buying company that is fundamentally sound and with sustainable grow business model, it is still a good choice for putting excess cash there. You must always have at least 3-6 months expenses budget before putting excess cash in the stock market or other asset classes other than fixed deposit. 

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