How low can stocks go? Updated risks and values – July 14th

How low can stocks go? Updated risks and values – July 14th

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: 12% from a record high
  • S&P 500: 7% from a record high
  • Nasdaq: 4% off a record high

Last week on a fundamental basis stocks were nearly as expensive as they’ve been since the pandemic began. I pointed out the last time stocks were as expensive on a trailing earnings basis, in early June,they promptly sold off. Sure enough we’ve seen selling over the past week with stocks off an average of 1% to 3%. As we’re getting ready for earnings season, in what's certain to be the worst quarter in the history of most companies reporting, the fundamental story will weaken. However, with California reclosing aspects of its economy as parts of South Florida have as well, there’s not a chance in hades companies will be providing meaningful guidance and the outlook is unclear over the near term. Add in a dose of Joe Biden posing a threat to President Trump and you don’t have the most appetizing recipe to be investing into right now.

If it sounds like I don’t have a lot of confidence in stocks currently – it's because I don’t. Over the short-term irrational selling and buying can and does take place in the stock market. In the end it comes down to fundamentals. As stock prices rise, it’s not necessarily because fundamentals are improving. It’s because of a hope that they will. Higher prices simply create more short-term risk if there’s a disappointment. That’s where we are right now.

We are we right now?

Here’s where the markets stand year to date.

  • The Dow is down 9%, the S&P 500 is down 2% & the Nasdaq is up 16%

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: 27.12
  • S&P 500 avg. P\E: 15.81

The downside risk is 42% based on earnings multiples right now from current levels. This is the worst valuation for stocks since the recovery from the Great Recession over a decade ago. Stocks are 6% more expensive than a year ago at this time on fundamental basis and earnings are only set to worsen. This isn’t the best of storylines over the short-term and I’d be cautious about investing additional money at these levels that may be needed in the short run. 

It's always important to ensure that you're positioned for negative adversity. If a 42% 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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