How low can stocks go? Updated risks and values – February 22nd, 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 follows...re the Dow, S&P 500 & Nasdaq stand against their all-time high levels:
- DOW: within 1%
- S&P 500: Record high
- Nasdaq: 2% off record highs
We enter this week of trading with stocks near record highs having touched them again early last week. This is something we’ve grown accustomed to. Despite concerns that the GameStop like activity was the sign of a top in the market, it hasn’t proved to be yet. Same could be said for other investment assets like Bitcoin for example. The reason stocks are essentially at record highs, is due primary to earnings season shattering expectations. With over 80% of companies reporting earnings, 79% have exceeded expectations. Earnings grew at a 3% rate year over year - they were expected to decline by 9% coming into the reporting season. This is huge outperformance by American companies. In fact, this is currently the third best relative earnings season in recorded history.
Here’s where the market stands based on fundamentals using the S&P 500 as the example.
- S&P 500 P\E: 39.78
- S&P 500 avg. P\E: 15.88
The downside risk is 60% based on earnings multiples right now from current levels. That's 22% 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. If the economy does continue to 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 60% 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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