November 22, 2014
Neil Irwin has an interesting piece noting the worldwide fall in commodity prices and interest rates has been accompanied by a rising stock market in the United States. While the piece approaches the issue from the standpoint that these movements present a seeming contradiction, that is not necessarily the case.
Falling commodity prices and interest rates can be the result of economic weakness, which is undoubtedly in part the case now. Other things equal, a weaker economy will mean lower future profits and thereby imply lower profits. However there are two countervailing factors. If economies in the U.S. and elsewhere strengthen, this would lead to tighter labor markets, that could lead to higher wages and therefore some reversal of the shift from wages to profits that we have seen since the downturn began.
The other point is that lower interest rates should be expected to be associated with higher stock prices, other things equal. The return on bonds and other interest bearing assets is the opportunity cost of holding stock. If this opportunity cost is lower, then people should be willing to pay more for the same share of stock. In this respect it is worth noting that stock markets have risen throughout the world, not just the United States. That would support the view that lower interest rates might be one of the main factors that are pushing stock markets higher.
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