How low can stocks go? Updated risks and values – August 3rd
Bottom Line: The purpose of this story is to inform you as to what's possible in a near worst-case outcome for the financial markets. The reason is to understand what's possible, though unlikely, so you can plan soundly for your financial future unemotionally. The US stock market is the greatest wealth creation machine in the history of the world. I want you to benefit from it without making emotional mistakes with money.
Too often when we have a rare short-term downturn in the markets - it's too late to offer up information that might have been helpful ahead of time. This week's edition of "how low can stocks go" goes as follows...re the Dow, S&P 500 & Nasdaq stand against their all-time high levels:
- DOW: 11% from a record high
- S&P 500: 4% from a record high
- Nasdaq: within 1% of a record high
Stocks were flat to higher over the past week as earnings season is in full swing. The market is currently full of horribly good reporting. Because of the pandemic earnings are terrible. GDP growth is terrible. But they are less terrible than anticipated. And less terrible is good in this market. It’s not without it’s risks however...On one hand 84% of companies which have reported so far have exceeded expectations. That’s helping support the market. On the other hand, earnings are 36% lower year over year for companies that have reported. The combination of high stock prices and significantly lower earnings recently led to a phenomenon that’s only played out four times previously in stock market history. A P/E or price to earnings ratio for the market exceeding 27 times earnings. That’s vastly higher than the average at around 16 times earnings. Yes, the feds are accommodating. Yes, lower interest rates make borrowing costs cheap for companies. No, there’s not a lot of value to be found currently in stocks.
If it sounds like I don’t have a lot of confidence in stocks at these prices currently – it's because I don’t. Over the short-term irrational selling and buying can and does take place in the stock market. In the end it comes down to fundamentals. As stock prices rise, it’s not necessarily because fundamentals are improving. It’s because of a hope that they will. Higher prices simply create more short-term risk if there’s a disappointment. That’s where we are right now.
We are we right now?
Here’s where the markets stand year to date.
- The Dow is down 7%, the S&P 500 is flat & the Nasdaq is up 16%
If only market fundamentals mattered here's what we'd want to consider regarding the S&P 500 for example.
- S&P 500 P\E: 28.12
- S&P 500 avg. P\E: 15.81
The downside risk is 44% based on earnings multiples right now from current levels. This equals the worst valuation for stocks since the Great Recession over a decade ago. Stocks are 8% more expensive than a year ago at this time on fundamental basis. It's always important to ensure that you're positioned for negative adversity. If a 44% decline wouldn't affect your day-to-day life, you're likely well positioned. If not, you should probably seek professional assistance in crafting your plan that balances your short-term needs with long term objectives.