With the current global health crisis forcing the stock market to crash and bond yields to stay low, fear and panic are on the rise that there will be no end in sight to the effects of the coronavirus pandemic on financial markets. Despite the despair and worry, there is some hope that the stock market might be able to rebound and that investment bonds may remain stable.
While short-term market volatility is inevitable in a risk-on environment, it is possible to gauge how much risk any specific business or investment will pose by looking at various factors. Evaluating the underlying conditions of a particular company or stock market drop is an important step in understanding the potential volatility of the stock. This analysis will help investors to make more informed decisions.
When analyzing the long-term effects of a particular stock or bond, investors should look at leverage and liquidity. Leverage is the ratio of borrowed money compared to the amount of money available to make investments. If a company is heavily leveraged, investors should be cautious as there is greater potential for the company to fail should it face debt or impairment issues. Inversely, a low leverage ratio indicates a strong, possibly safe company and investment.
Liquidity, on the other hand, measures the amount of assets available for a company to use as opposed to their liabilities. A company with healthy liquidity ratios has enough assets to cover their liabilities over the long term. This factor is especially important to assess since the potential for descent into a financial crisis increases with every lowering of liquidity levels.
For those worried about the stock market in general, the important figure to look at is the VIX index. The VIX is a measure of volatility and essentially tracks the market’s expectations for near-term volatility. The higher the VIX, the more uncertain the market is. Values in the 30 range generally indicate high levels of volatility, while a return to the 10-20 range suggest that the market is less volatile.
The stock and bond markets will certainly remain volatile in the coming weeks and possibly months, but it is not necessarily time to panic. Those who consider investing should take time to analyze the various risks involved, taking in the various factors discussed, to make well-informed investing decisions.
