How low can stocks go? Updated risks and values for February 20th

posted by Brian Mudd -

How low can stocks go? Updated risks and values for February 20th   

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: off 5.2% (up 2.4% vs last week) 

  • S&P 500: off 4.9% (up 2.6% vs last week) 

  • Nasdaq: off 3.5% (up 3.5% vs last week) 

It happened...What's that? The inevitable volatility that'd been absent from the market. In a separate story today, I'm sharing the great news from earnings season. Now on one hand you'll be inclined to think something's wrong based on the quick market correction in recent days. That's not the case at all. This was a healthy market correction. And as we've seen, despite the average stock having declined by at least 10% during the peak of the selling - half, or more, of the losses during the correction have already come back into stock prices. It's hard to keep the market down with 15%+ earnings growth! 

We have record earnings and tax reform. And here's the thing. The big thing. Even before the correction stock prices hadn't really been more expensive in early 2018 than they were a year ago. 

Here's the 2018 year-to-date performance:        

  • The Dow is up 2%, the S&P 500 is up 2.2% & the Nasdaq is up 4.9%. It's noteworthy that all three are higher against this time last week despite the roller coaster ride.  

As far as how low stocks could go...? 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: 25.52            

  • S&P 500 avg. P\E: 15.69              

The downside risk is 39% based on earnings multiples right now from current levels. That's 1% less risk compared with this time last year on a fundamental basis alone (and 2% more than last week). We're seeing earnings season once again deliver & with the recent selloff the fundamental story hasn't changed – valuations are just a touch lower. We still don't have the full impact of tax reform factored in.  

Now, as always, I don't expect that type of selloff to occur (39%) 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).    

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