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Investment Commentary

Another 20%?!

By Brian Andrew | Johnson Financial Group • October 13, 2022

3 minute read time

Recently, Jamie Dimon, CEO of JP Morgan, stated on CNBC that the stock market could decline “another 20%.” That made headlines all over as people thought about what that would mean to portfolios that have already taken a beating. Let’s break down why he might draw that conclusion and what we can do to examine your own portfolio’s risk.

In thinking this through, we need to keep in mind that stocks produce a better return over long periods of time because they’re riskier than many other assets. Price volatility is part of the game. But that doesn’t mean Mr. Dimon is necessarily correct.

Down 20%

So far this year, the S&P 500 Index is down about 25%. Most of this decline has happened because interest rates have risen three percentage points since the beginning of the year, which is very fast! Why? The Federal Reserve is concerned about how high inflation is and how long it has been this way. The Fed has admitted through policy that it waited too long to start raising rates and so has been playing catch up.

Stock prices are really just future company earnings discounted by an interest rate to the present. The higher the interest rate, the lower the price. (Simple example: $3 of earnings divided by 1% = $300, whereas $3 divided by 4% = $75.) So, as a result of higher interest rates, stock prices have adjusted.

If you think the Fed has to raise rates another percentage point or more, then stocks will continue to decline. (To continue the example, $3 divided by 5% = $60 … or another 20% drop.)

So, if Mr. Dimon, like other investors, believes the Fed has more work to do to combat inflation, then stocks are likely to move lower.

In addition, company earnings growth and the expectations for that growth have softened with the economy. Since stock prices are based on future earnings growth, the lower the expectation, the more likely prices will decline.

The odds of a recession have risen with higher interest rates, more expensive gas and home mortgages and slower wage growth. This leads investors to reduce earnings expectations.

We’ll get another look at corporate earnings for the third quarter beginning this Friday, when Mr. Dimon and JP Morgan will tell us how they did and what they expect for the future.

Scenario analysis

The way we deal with these different possibilities is to run a scenario analysis on our portfolio strategies each month. We look at what we think is most likely—our base case—and then a worst case and a best case. Our risk tool allows us to estimate the probable portfolio performance given those scenarios. We can also look at history and look for similar environments and determine how portfolios may perform.

Advisor help

With this scenario analysis in hand, advisors can look at a client’s financial plan and estimate the impact of a further decline in asset prices. That doesn’t mean you need to make a change, though it may provide some comfort knowing how probable your plan’s success is if markets decline further.

Keep in mind that the stock market, while down 25% is back to where it was early in 2021. If your situation hasn’t changed much, and your plan was on track then, it likely is today. The best way to review the scenarios and your plan is to talk with your advisor.

The stock market is volatile, especially so when there is greater uncertainty about the level of interest rates and the direction of economic and earnings growth. This volatility is why, over time, stocks deliver a higher return and likely are in your portfolio.

Mr. Dimon has an opinion and is welcome to share it. He does not, however, have a crystal ball. Nor do we. What we do have is a team of advisors who understand how risk and financial planning provide comfort during times of volatility.

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