How low can stocks go? Updated risks and values for August 22nd:
Bottom Line: In case you're new to this series, 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. 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: 2% off of highs
- S&P 500: within 2.5% of highs
- Nasdaq: about 3.8% off of all-time highs
Earnings have been awesome in 2017. But the past week hasn't been for stocks. For most of 2017 record earnings have ruled the day. Coming into the second quarter earnings season estimates for year over year growth were at 6.2%. With the season just about completed growth has been over 10% resulting in record earnings for the S&P 500 and the stock market generally! That's why stocks had been able to continue to push to record highs. Record profits, record stock prices. Kinda adds up. As a result the disappointments on healthcare and tax reform to date hadn't mattered as much. Last week that began to change a bit. For the first time since November's election, we've seen outside factors (geopolitics - perceived weakness of President Trump) begin to impact investor psychology. This isn't surprising given the record high prices (almost all investors are sitting on significant profits ), we're overdue for a correction in stocks and we're in August which is the 2nd worst month of the year historically for the market (with September being the worst).
That being said the returns have been impressive to say the least. The Dow is up 9.8% in 2017, the S&P 500 is up 8.5% & the Nasdaq has been the biggest winner up by 15.4%.
As far as how low stocks could go...If only market fundamentals mattered here's what we'd want to consider with regard to the S&P 500 for example.
- S&P 500 P\E: 24.21
- S&P 500 avg. P\E: 15.66
The downside risk is 35% based on earnings multiples right now from current levels. That's 1% less risk than a week ago and about 5% less risk than entering 2017 despite stocks having appreciated so significantly this year already. 2017 is proving the power of improved earnings. With the super-strong growth year over year, stock prices are meaningfully higher as compared to the start of 2017, yet risk has actually declined because fundamentals have improved faster than prices have risen.
Now, as always, I don't expect that type of selloff to occur (35%) but its always important to ensure that you're positioned for negative adversity. If a short-term decline at the aforementioned levels wouldn't affect your day-to-day life, you're likely well positioned to continue to take advantage of investment opportunities. If that size of selloff would rock your world over the short-term, that's when you should probably seek professional assistance in crafting your plan (that balances your short-term needs with long-term objectives).