Why stocks are falling via /r/wallstreetbets #stocks #wallstreetbets #investing

Why stocks are falling

1) The vaccine news is big

It means we are going to open up sooner rather than later, which is going to cause massive rise in economic activity and thus inflation. Because of this, the market is expecting an increase in long run interest rates, as seen by rise in long term yields.

2) Why higher rates are bad for stocks

The value of a company's stock = the expected free cash flows to stockholders of the company, discounted back to their present value (cash flow in yr 4 worth less than year 3 at the company's cost of equity (which is a fancy term for risk, and reflects the opportunity cost of similar investments).

The main mathematical model to define cost of equity involves taking the risk free rate (long term US treasury rate) and adding a premium for the riskiness of the stock market as a whole times a multiplier for the riskiness of the company relative to the rest of the stock market.

Higher long term yields means the risk free rate goes up, which pushes up the cost of equity (opportunity cost of capital) for all stocks in the market–> a higher cost of equity means each future cash flow gets discounted more, and so the value of the company decreases

TL;DR– Vaccine increased inflation expectations, which pushed up long term yields. Higher yields increase the opportunity cost of capital, which mean that future cash flows of all companies are worth less. Tech especially is hurt by this because they are growth companies and the bulk of their cash flows occur far in the future and are thus more sensitive to discounting.

Submitted November 10, 2020 at 05:22AM by YoinkedMustache
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