Jim Niedelman:
It is 4 Your Money time. We are joined by James Nelson, financial advisor of NelsonCorp Wealth Management, great to see you, James.

James Nelson:
Thanks for having me Jim.

Jim Niedelman:
Absolutely. Well it it seems like several areas of the financial markets have been under some pressure recently, what are you saying?

James Nelson:
Yeah, they have. If you’ve paid attention to the news the last couple of weeks the stock market’s been beat up a little bit, but it hasn’t been everybody. The Dow Industrial, the S&P 500 for the most part have held their own, S&P is about 4% off the peak, but the NASDAQ’s what we’re really looking at. Growth stocks specifically, technology have come under some pressure and are about 10% off their peak in the last couple of weeks, and a lot of that we attribute to the rise in interest rates. The 10 year government bond has gone from 1% to 1.6% in a pretty short amount of time, and the growth stocks are really feeling the heat.

Jim Niedelman:
Along those lines then what is it about the growth in technology companies that made them susceptible to rising interest rates?

James Nelson:
Yeah. So we’ve got a chart here that’s going to help us illustrate this, and this chart here interest rates played an important role in determining the discount rate used in cash flows. Fundamental analysis of financial assets almost all use discounted cashflow analysis.

James Nelson:
To understand why the rise of interest rates have hurt growth stocks more, it’s helpful to know the calculations that they use. So the chart here, we are performing a discounted cashflow calculation on a hundred dollars, and that cashflow goes indefinitely similar to stock earnings. So the blue bars represent cashflow with a 5% growth, and red bars represent 1% growth rate. The pair of bars on the left show a 7% cost of capital, this is the number influenced by interest rates. As expected the blue bars with the 5% growth rate is higher than the red bar 1% growth rate.

James Nelson:
So on the other side of the chart we run the exact same calculation with an 8% cost of capital. While the blue bars are still higher than the red, look at the change in that value, the cash flow with the higher growth rate declined by 33% when the discount went up only 1%, while the lower growth rate only declined by 14%. So this chart really shows how higher rates of growth are more sensitive to changes in the discount rate and interest rates.

Jim Niedelman:
All right, now put it all together for us, what should people at home watching be thinking about when it comes to their investments?

James Nelson:
I think it depends on their view of interest rates and the economy in general. If you believe that the interest rates are going to continue to go up, economic data continues to be pretty solid, these growth stocks are probably going to continue to get hit. More of the cyclical and value type investments might be a better play. However, if you’re on the other side of the camp and you think that interest rates have gone up enough and they’re probably going to level off, might be a decent buying opportunity into some of these growth stocks that have been hit in recent weeks.

Jim Niedelman:
James Nelson, NelsonCorp Wealth Management, great insight as always James.

James Nelson:
Thanks Jim.

Jim Niedelman:
And if you missed any of our discussion we’ll make it available for you on OurQuadCities.com.