How low will stocks go? Updated risks and values – September 9th

How low will stocks go? Updated risks and values – September 9th

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: 7% from record highs
  • S&P 500: 7% from record highs
  • Nasdaq: 10% from record highs

Just like that, within a week, the Nasdaq went from record highs to correction territory – with a decline of 10%. With earnings season in the rearview mirror and stocks needing fundamental improvement to justify lofty prices a dose of reality and nervousness has entered the market. As I’ve been reporting weekly with this story of late, stock valuations were the highest they’ve been in over a decade. That was based on an expectation of improvement. Now those expectations have to become reality to justify prices. That made and still makes the current market rather risky from a risk-reward perspective.

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 4%, the S&P 500 up 3% & the Nasdaq is up 21%

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: 30.16
  • S&P 500 avg. P\E: 15.81

The downside risk is 45% 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 9% more expensive than a year ago on fundamental basis. It's always important to ensure that you're positioned for negative adversity. If a 45% 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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