How low can stocks go? Updated risks and values – August 24th
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 follows...re the Dow, S&P 500 & Nasdaq stand against their all-time high levels:
- DOW: 6% from a record high
- S&P 500: Record high
- Nasdaq: Record high
Stocks were generally higher again over the past week as optimism reigns supreme on Wall Street. This culminated at ending the week with record highs once again for the S&P 500 and Nasdaq as technology and consumer products companies, which have benefited from the pandemic, continued to power to new records. This market certainty isn’t without its risks... We concluded a record setting earnings season in two respects. A record 80%+ of companies exceeded earnings expectations, meanwhile a record earnings decline of over 30% also took place. This places a higher level of risk in the markets if there isn’t a near-term rebound in the economy that’s as strong as what’s now been priced into stocks.
Yes, the feds are accommodating. Yes, lower interest rates make borrowing costs cheap for companies. No, there’s not a lot of value to be found currently in stocks. 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.
Here’s where the markets stand year to date.
The Dow is down 2%, the S&P 500 up 5% & the Nasdaq is up 26%
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: 29.2
- S&P 500 avg. P\E: 15.81
The downside risk is 46% based on earnings multiples right now from current levels. This equals the most expensive valuation for stocks since the Great Recession over a decade ago. Stocks are 10% more expensive than a year ago on fundamental basis. It's always important to ensure that you're positioned for negative adversity. If a 46% 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.