How low can stocks go? Updated risks and values – May 5th

How low can stocks go? Updated risks and values – May 5th

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:20% off record high
  • S&P 500: 16% off record high
  • Nasdaq: 12% off record high

The market took a bit of a breather over the past week as we wrapped up the best month for stocks in 82 years. It might not feel that way after the record fast fall in March, but that’s the case. It’s but the latest reminder to not let your money and emotions cross paths. Selling at the lows in March would have left you missing out on returns of around 20% over the past five weeks. The question now is...where do we go from here? It’s a good question. 34 states are currently reopening – including most of Florida. But most industries remain closed or severely hamstrung during phase one reopening measures. It’s not a recipe for a V shaped recovery – especially with 30 million people unemployed – 24 million more than before the pandemic. Still progress is progress and the key here is to not backslide based on reopening's. The good news from the states which reopened earliest – is that each one of them has fewer diagnosed cases now than on April 24th when the reopening began. The better news comes over the next couple of weeks if phase one goes well. Two weeks of sustained progress allows for phase two reopening. And two positive weeks from there allows the new normal. If all breaks well everywhere – all 34 states could be fully reopened by June. Fingers crossed.Earnings season has panned out a bit better than anticipated thus far, but mostly, the belief is that the worst in the pandemic is behind us and the economy will begin to improve from here. Given the trillions pumped into the financial markets by the fed, along with stimulus spending by Congress, the money has to go somewhere and much of it is finding its way into equities. This is similar to what we saw coming out of the Great Recession a decade ago with a combination of bailouts, stimulus and QE. If it proves to be a repeat, investors will be happy with their recent investments over the long run. But the longer-term question is still about fundamentals – not blind optimism. If we hit stumbling blocks during the reopening process and/or if the economic damage is worse than currently anticipated – there's a fair amount of downside risk in the markets. Earnings follow-through will need to happen down the road. 

Here’s where the markets stand year to date.

  • The Dow is down 17%, the S&P 500 down 12% & the Nasdaq is down 3%

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: 20.38
  • S&P 500 avg. P\E: 15.78

The downside risk is 23% based on earnings multiples right now from current levels. That's 10% less risk compared with this time last year, however fundamentals on trailing earnings will deteriorate. The market is priced as though earnings will only drop by about 10% this year. That might be a bit too optimistic. I’d prepare for the additional 23% drop at this point with a further reevaluation as earnings begin to roll in – just in case.

It's always important to ensure that you're positioned for negative adversity. If another 23% 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.

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