How low can stocks go? Updated risks and values – October 12th

How low can stocks go? Updated risks and values – October 12th

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: 3% from record highs
  • S&P 500: 3% from record highs
  • Nasdaq: 4% from record highs

We've had two straight weeks of strong gains for stocks which have left all of the major indexes closer to record highs than correction territory (a decline of 10% or more). And who might have guessed that when President Trump was first diagnosed with COVID-19? With President Trump deemed healthy to resume campaigning and the Election just a few weeks away, I think markets are telling you something most pollsters aren’t...that President Trump is well positioned to win. President Trump easily leads Joe Biden on economic matters regardless of pollster. It’s unlikely to think most voters who say they’re better off financially than four years ago (according to Gallup 56% of voters say they are better off), are going to vote the opposite of how they did four years ago. That’s just no logical, nor is there any president for it. In fact, a president polling above 50% of the “four years ago” question has never lost.

Markets will continue to be driven mostly by anticipation of Election Day between now and then. 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 flat, the S&P 500 up 6% & 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: 35.04
  • S&P 500 avg. P\E: 15.85

The downside risk (if the near-worst case outcome for the economy/markets occurred) rose to 54% based on earnings multiples right now from current levels. Stocks are 16% more expensive than a year ago on fundamental basis. This is the most expensive stocks have been based on training 12-month earnings in the history of this series (dating back to 2010). It’s clear there’s a lot of risk back into the market currently. It's always important to ensure that you're positioned for negative adversity. If a 54% 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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