How low can stocks go? Updated risks and values – January 28th

How low can stocks go? Updated risks and values – January 28th

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 the Dow, S&P 500 & Nasdaq stand against their all-time high levels:                           

  • DOW: 3% off record high
  • S&P 500: 3% off record high
  • Nasdaq: 3% off record high

The market was rolling merrily along setting record highs along the way until Friday. That’s when the Coronavirus threat became real to investors. Fear of contagion world-wide. Fear of travel disruptions. Fear of impaired economies – especially in China, all started to become reality. A big down day on Friday was usurped by the major averages all giving back around 2% yesterday. Add in concerns about Bernie Sanders gaining traction in the Democrat’s race and any additional weakness perceived for President Trump during this impeachment trial and you have the perfect recipe for the two-day selloff we’ve seen. But perspective is always key and here’s where we now stand.

Year to date...

  • The Dow is flat, the S&P 500 is flat & the Nasdaq is up 2%        

So basically, the market is still flat to up for the new year after the recent selling. Not too shabby, especially coming off of 30% gains last year.

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: 24.41
  • S&P 500 avg. P\E: 15.78

The downside risk is 35% based on earnings multiples right now from current levels. That's 13% more risk compared with this time last year. That’s exaggerated due to the stock market correction that occurred last January on the unfounded fears of the partial government shutdown. Still,the market isn’t cheap at these levels and that’s part of the reason why more negative volatility is possible. Stocks aren’t cheap so earnings growth needs to occur. Anything that’s perceived to hurt earnings is likely to be met with selling as we’ve seen. Earnings season has been positive to date though, so there’s still good news based on what’s been and is being reported. 73% of companies have exceeded earnings expectations thus far during earnings season. 

I don't expect a 35% selloff but it's always important to ensure that you're positioned for negative adversity. If a short-term decline at those levels 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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