The stock market got off to a rough start in 2022. The S&P 500 index slid by nearly 10%, and many growth stocks have taken much bigger hits, trading down 50% or more from their 52-week highs.
As an investor, volatility like this can make your stomach churn. But long-term investors know that it's essential to stay the course on their investment decisions and ride out the short-term volatility. It also helps to have a diversified portfolio that includes stocks that even things out.
One dividend stock that can help you do that is Virtu Financial (VIRT +0.20%). As a business that helps investors buy and sell stocks, it stands to benefit if markets remain volatile. That fact, along with a solid dividend that at current share prices yields more than 3%, makes this a company that can help you relax in times of worry.
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Understanding 2022's volatile start
It seems investors' main concern right now is inflation, which has surged worldwide because of hangover effects from conditions earlier in the pandemic. These effects include pervasive supply chain issues, strong consumer spending, high levels of stimulus spending, and central banks' loose-money fiscal policies. Since March 2021, the U.S. consumer price index has shown year-over-year increases of 4% or higher each month.
In response to all this, the Federal Reserve has given clear indications it plans to take action to cool down inflation. This means a slow wind-down of looser monetary policies and a likelihood of raising benchmark interest rates from their current rock-bottom levels. The Federal Open Market Committee (FOMC) has said it's expecting to make three 25-basis-point hikes in the key fed funds rate this year, but economists at various big banks anticipate even more. Analysts at Bank of America predict the most aggressive course of action: Seven rate increases this year -- one following every remaining FOMC meeting.
While low and falling interest rates provide a tailwind for growth stocks, rising interest rates have the opposite effect. In an interview by Institutional Investor, Damian Handzy, head of research at Investment Metrics, noted that "the more interest rates go up, the more value [stocks] win." This could explain why so many equities have been falling so far this year -- and, in particular, growth stocks that were previously carrying lofty valuations.
What causes market volatility
Volatility is simply a measure of how sharply the stock market's value is moving up and down. Wide oscillations are usually due to uncertainty or fear about what the future has in store. Although volatility rises when stocks sell off, higher volatility simply means that stocks are moving both up and down more than usual.
The bid-ask spread is the difference between the price someone is offering to pay for an asset and the price at which someone else is willing to sell it. When market volatility rises, the bid-ask spread widens out. Higher volatility also brings higher trading volumes as investors jockey for position. As a market-making firm, Virtu Financial benefits from both of those conditions.
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Why Virtu Financial embraces higher volatility
Market makers provide liquidity to global markets, making it easy and more efficient for traders to complete the stock and options trades they want to make. These firms stand ready to take orders at a moment's notice, and the ability to make use of their services is a big reason why more trading platforms have been able to shift to zero-commission trading models.
Instead of charging commissions on trades, market makers find their profits in the bid-ask spread -- buying shares and almost instantly reselling them slightly higher. In calm markets, bid-ask spreads tend to be tight. However, when there is higher uncertainty in markets, bid-ask spreads widen, and market makers like Virtu Financial benefit.
When the coronavirus pandemic emerged in early 2020, markets become highly volatile, and market makers like Virtu Financial crushed it. With elevated volatility for most of 2020, Virtu posted record earnings, with revenue up 113.5% to $3.2 billion while net income came in at $1.1 billion after it posted a loss in 2019.
However, investors should recognize the cyclical nature of this business model. Through the first nine months of 2021, the firm's revenue dropped 18% year over year, and net income slid by nearly 31% as market volatility eased.
If inflation were to subside without significant interventions from the Federal Reserve, and the central bank held off on raising interest rates, the stock market would likely calm down. However, if market volatility stays elevated while interest rates rise -- as many economists expect -- Virtu Financial will be there to take advantage, making its stock a solid buy now.
