How Low Can Stocks Go? Updated Risks & Values – August 2nd, 2021

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How Low Can Stocks Go? Updated Risks & Values – August 2nd, 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. 

Here's where the Dow, S&P 500 & Nasdaq stand against their all-time high levels:

  • DOW: within 1% of a record high
  • S&P 500: within 1% of a record high
  • Nasdaq: 1% off a record high

Stocks were mostly flat last week after the recent run to record highs on back of phenomenal earnings. In the financial markets anything can happen over short windows of time. In the end it’s fundamentals, earnings, that drive stock prices. Despite the stock market already having priced in lofty expectations coming into earnings season, companies have delivered big time which have allowed stocks to remain near their highs as other economic factors like inflation and a slowing economy are considered. Through Friday 59% of companies had reported earnings for the second quarter. The results are currently record setting. 

  • 88% of companies have exceeded earnings expectations
  • The average beat is by 17%

If those remarkable trends hold through earnings season, it will go down as the best relative to expectations in recorded history. Importantly for investors, it helps justify stock prices at record high levels. The fundamental story for stocks remains a great one. 

As we enter this week here’s where the market stands based on fundamentals using the S&P 500 as the example.

  • S&P 500 P\E: 34.28
  • S&P 500 avg. P\E: 15.94

The downside risk is 54% based on earnings multiples right now from current levels. That's flat compared to a week ago, but 11% lower than at the start of earnings season.  That’s the power of improved earnings helping to justify stock prices which also mitigates risk. This will continue throughout the earnings season, and we’ll have a good picture of how the market is really valued from a risk perspective at the end of earnings season. If inflation and the virus don’t derail the recovery there’s a lot to feel good about from an investor’s perspective. 

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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