How low can stocks go? Updated risks and values – May 26th

How low can stocks go? Updated risks and values – May 26th

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: 17% off record high
  • S&P 500: 13% off record high
  • Nasdaq: 5% off record high

Markets were flat to slightly higher over the past week as investors attempt to digest next steps for our society, economy and weigh the development for a vaccine and treatment options for COVID-19. Without question stocks are performing better than the economy as a whole right now. With nearly 40 million unemployed – compared to only a little more than 6 million before all of this began – it's remarkable how the markets have held up. Of course, much of this has to do with the fed’s pumping of trillions of dollars into the system. But, if you’re looking for potential upside from here (or wondering if it’s possible), investors have about $4 trillion dollars on the sidelines right now. If we do see confirmation of a bottoming in our economy, there’s a good chance much of that money would make its way into stocks. We’re now in a market like what we had coming out of the Great Recession. One where stocks perform better than the real economy due to a need for yield and a place for money to go. That’s not to say it’s all up from here. Another number of unforeseen events could create problems. Not to mention the markets wouldn’t respond positively to Trump losing in November. The election cycle will factor into the volatility in the markets between now and then. 

Here’s where the markets stand year to date.

  • The Dow is down 14%, the S&P 500 down 8% & the Nasdaq is up 4%

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: 21.18
  • S&P 500 avg. P\E: 15.78

The downside risk is 25% based on earnings multiples right now from current levels. That's 8% 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 8% this year. That might be a bit too optimistic. I’d prepare for the additional 25% 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 25% 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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