How Low Can Stocks Go? Updated Risks & Values – July 19th, 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.
Here's where the Dow, S&P 500 & Nasdaq stand against their all-time high levels:
- DOW: 1% away
- S&P 500: 2% away
- Nasdaq: 2.5% away
A week ago, the consensus was the COVID-19 variants wouldn’t be shop stoppers, earnings would be awesome, and inflation would be temporary. By Friday, there were doubts about two of those. Let’s start with the awesome. Coming into earnings season, growth was expected to be 64% year over year. It’s been even better. Through the first week of earnings season, with 8% of companies reporting, growth’s checking in at 69% over last year’s lockdown second quarter. That’s the second highest year over year gain in recorded history. Most importantly for now, it helps justify the lofty prices of stocks entering the earnings season. About the buts though. Core inflation is the highest in 30 years, and some are now doubting how temporary inflation will be. With US energy supplies restrained by the Biden administration, we’re back to OPEC watching ( (they did announce supply increases over the weekend) and new COVID cases are back to the highest levels since early April. If it were just about a summer spike in cases that’d be one thing. The bigger thing is if the vaccines aren’t all that effective against the variants which increasingly appears to be the case. But hey, this is a story about stock market fundamentals and values and so earnings will win the day in the end.
As we enter this week here’s where the market stands based on fundamentals using the S&P 500 as the example.
- S&P 500 P\E: 45.97
- S&P 500 avg. P\E: 15.98
The downside risk is 65% based on earnings multiples right now from current levels. That's 31% more risk compared with this time last year but one percent better than last week as the onset of the improvement in earnings is felt in the market. That being said... The market remains historically expensive right now. Stocks are priced for earnings to continue to rebound. If the economy does continue to recover as expected, stock prices can be justified. If something were to come out of left field – there’s clearly 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 65% 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.