Chief Investment Officer | Johnson Financial Group
As Chief Investment Officer, Brian Andrew leads Johnson Financial Group's investment strategy to provide consistent, actionable investment solutions for our clients.
6 minute read time
Markets have been very volatile since the year began. Whether you are invested in stocks, bonds, real estate, cryptocurrency, or any other asset, you’ve seen tremendous volatility in prices. It may seem like everything is down. However, that is not the case. Let’s explore where this volatility is coming from and what’s changed since the beginning of the year to create an abundance of it. And, while you might hate math, we’re going to use some to explain the markets’ volatility.
There are several methods for valuing a stock; let’s use a simple one, the dividend discount or Gordon growth model. This model says the value of a stock, its price, is a function of a company’s potential future earnings (paid out as dividends) discounted by a required return rate minus the growth of those dividends. The formula for a stock price then looks like this:
P=Stock Price; D=Dividends; r= required rate of return and g=growth rate of dividends (or, if all cash is paid out in dividends, then the growth rate of the company’s cash flow).
Now imagine a market where people feel good about the return they’re getting because interest rates are near 0% and anything is better than that. And company growth is accelerating because companies are improving earnings and cash flow as they recover from the 2020 beginning of the pandemic. Sounds like 2021 doesn’t it?
If you change both the sentiment regarding the required rate of return and prospects for dividend growth in a short period of time, then the outcome of the formula above becomes less clear. When we say markets don’t like uncertainty what we really mean is they don’t like not knowing what “r” and “g” are going to look like in the future.
As we entered 2022, it was clear that the Federal Reserve was going to leave the markets’ party. The Fed was forecasting an increase in short-term interest rates and said it would reduce purchases of bonds, which adds liquidity to the financial system (like oil in a car engine).
Because people are obsessing about whether inflation is transitory or permanent, and because interest rates have been near 0% for so long, any change in interest rate levels creates uncertainty. Those who believe that inflation is here to stay want more interest rate hikes from the Fed because they believe it will cool the economy and lower inflation.
This information is for educational and illustrative purposes only and should not be used or construed as financial advice, an offer to sell, a solicitation, an offer to buy or a recommendation for any security. Opinions expressed herein are as of the date of this report and do not necessarily represent the views of Johnson Financial Group and/or its affiliates. Johnson Financial Group and/or its affiliates may issue reports or have opinions that are inconsistent with this report. Johnson Financial Group and/or its affiliates do not warrant the accuracy or completeness of information contained herein. Such information is subject to change without notice and is not intended to influence your investment decisions. Johnson Financial Group and/or its affiliates do not provide legal or tax advice to clients. You should review your particular circumstances with your independent legal and tax advisors. Whether any planned tax result is realized by you depends on the specific facts of your own situation at the time your taxes are prepared. Past performance is no guarantee of future results. All performance data, while deemed obtained from reliable sources, are not guaranteed for accuracy. Not for use as a primary basis of investment decisions. Not to be construed to meet the needs of any particular investor. Asset allocation and diversification do not assure or guarantee better performance and cannot eliminate the risk of investment losses. Certain investments, like real estate, equity investments and fixed income securities, carry a certain degree of risk and may not be suitable for all investors. An investor could lose all or a substantial amount of his or her investment. Johnson Financial Group is the parent company of Johnson Bank and Johnson Wealth Inc. NOT FDIC INSURED * NO BANK GUARANTEE * MAY LOSE VALUE