How low can stocks go? Updated risks and values – October 19th

How low can stocks go? Updated risks and values – October 19th

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: 3% from record highs

After two straight weeks of strong gains for stocks, they were mostly flat over the past week. All major indexes are little more than a good day away from record high territory which is remarkable considering the year it’s been and all the economy has been through. With only a couple of weeks to go before Election Day, 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. Markets have rallied solidly since that Gallup survey was released.

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 27%

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: 35.11
  • S&P 500 avg. P\E: 15.85

The downside risk (if the near-worst case outcome for the economy/markets occurred) rose to 55% based on earnings multiples right now from current levels. Stocks are 17% 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 55% 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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