Investing During a Recoveryby Eric Petroff
One of the side effects of low interest rates is they tend to create demand for higher return, higher risk investments. So, as recessionary expectations bottom out, pessimism fades away and optimism works its way back into people's minds. Moreover, investors re-examine opportunities for riskier investments in the context of what is usually a low interest rate environment. They also embrace risk. As a result, equity markets tend to do very well during economic recovery. Within equity markets, some of the best performing stocks are those that use operating leverage as part of their ongoing business activities, especially as these are often extremely undervalued after being beat up during the market downturn. Remember, leverage works great during good times, and these firms tend to grow earning faster than companies without leverage, but they also face real risks during weakening times. Moreover, growth stocks and small stocks tend to do well as investors embrace risk during an economic recovery.