How low can stocks go? Updated risks and values – March 1st, 2021
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: off 3.3%
- S&P 500: off 3.5%
- Nasdaq: off 6.9%
We start the week against the backdrop of inflation fears hitting the market late last week which brought about heavy selling – especially in technology companies. With historically high valuations for technology companies, any perceived bump in the road going forward is likely to be felt. The selling in technology has the Nasdaq closer to correction territory than it does record highs. The more optimistic view currently came in the form of earnings. With earnings season over, American companies had their 2nd best quarter relative to expectations on record. Coming into the reporting season, earnings were expected to have declined by 9% year over year. Instead, they grew by 2% with nearly eight out of every ten companies having positive surprises. Stocks can doing anything over short windows of time but ultimately, it’s fundamentals that determine valuations.
Here’s where the market stands based on fundamentals using the S&P 500 as the example.
- S&P 500 P\E: 38.8
- S&P 500 avg. P\E: 15.89
The downside risk is 59% based on earnings multiples right now from current levels. That's 23% more risk compared with this time last year. The market remains historically expensive right now. Stocks are clearly priced for earnings to continue to rebound in 2021. If the economy does continue to recover as expected, stock prices can be justified. If there’s a double-dip recession – hold your butt. There’s a lot of room for downside. That’s basically where we are right now.
It's always important to ensure that you're positioned for negative adversity. If a 59% 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.
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