How low can stocks go? Updated risks and values – February 1st, 2021

How low can stocks go? Updated risks and values – February 1st, 2021

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: 4% off
  • S&P 500: 4% off
  • Nasdaq: 5% off

Raise your hand if you had GameStop becoming the biggest storyline in the stock market for the first month of the year? Unless you’re a WallStreetBets Reddit user, it wasn’t even on your radar, that is until it was on everyone’s radar. A 2021 version of the 90’s internet chat room schemes to attempt to pump up penny stocks, Reddit users have effectively taken the most shorted stock in the market, GameStop, from $2.57 per share to $325 as of Friday’s close. Short sellers, mainly hedge funds, have been caught in the most prolific short squeeze in American stock market history. Where does it go from here? Hard to know, expert opinions have been wrong to date as they’ve suggested the stock would quickly come crashing back down. It hasn’t happened yet.

The effect of the GameStop story sparked selling in an already pricy stock market as valuations for companies were already the fourth highest they’d been in history prior to selling entering the markets last week. In some cases, hedge funds have had to sell equity positions to cover their GameStop loses. That’s how the market is directly linked to the GameStop story, aside from concerns it could happen elsewhere. And oh by the way, it’s still earnings season. Speaking of which... With 37% of companies reporting, 82% have exceeded earnings estimates – the second highest percentage of beats in history. That’s important with stocks generally being expensive from a historical perspective.

Here’s where the market stands based on fundamentals using the S&P 500 as the example.

  • S&P 500 P\E: 37.82
  • S&P 500 avg. P\E: 15.88

The downside risk is 58% based on earnings multiples right now from current levels. That's 20% more risk compared with this time last year. The market is historically expensive right now. Stocks are clearly priced for earnings to rebound in 2021. It’s mostly like this. If the economy does recover as expected stock prices can be justified. If there’s a double-dip recession – hold your butt. There’s a lot of room for downside. That’s basically where we are right now.

It's always important to ensure that you're positioned for negative adversity. If a 58% 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.

Photo Credit: Getty Images

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