How low can stocks go? Updated risks and values for January 30th
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: Within 1% of all-time high
S&P 500: ""
Nasdaq: ""
2018 has picked up where 2017 left off. After gains averaging about 20% to 30% we're not seeing any signs of selling. In fact, the S&P 500 is off to its best start to a year in 31 years (1987) despite yesterday's selloff. With nine straight months of strong economic growth. Record earnings, tax reform, the end of the individual mandate. There's been endless room for optimism. And here's the thing. The big thing. Stock prices haven't really been more expensive in early 2018 than they were a year ago at this time. How you ask? Because stock prices have only risen in conjunction with improved earnings performance.
Here's the 2018 year-to-date performance:
- The Dow is up 7%, the S&P 500 is up 6.7% & the Nasdaq is up another 8.2%. That's a heck of a run to start the year.
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: 26.65
S&P 500 avg. P\E: 15.69
The downside risk is 41% based on earnings multiples right now from current levels. That's only 1% more risk compared with this time last year on a fundamental basis alone (and it's the same as last week despite another week of gains). We're seeing earnings season once again deliver with earnings that are keeping up with stock price gains & we still don't have the impact of tax reform factored in. For the S&P 500 specifically, the average tax rate was about 26% last year. With tax reform cutting corporate rates to 21% - that's another 5% to the bottom line on average.
This is the power of improved earnings. With the super-strong growth year over year, stock prices are meaningfully higher as compared to this time last year, yet risk hasn't changed much because fundamentals are improving as fast as prices. The most common question I'm asked is when this will end. While short-term movements are unpredictable, the longer term fundamental story has only continued to improve. As long as that's the case, you probably have your answer...
Now, as always, I don't expect that type of selloff to occur (41%) but it's 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).