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How Low Can Stocks Go? Updated Risks & Values – September 27th, 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. My first rule of money is to never let your money and emotions cross paths. That’s what this is about, an analytical evaluation of the stock market.
Here's where the Dow, S&P 500 & Nasdaq stand against their all-time high levels:
- DOW: 2% off recent highs, +14% YTD
- S&P 500: 2% off recent highs, +19% YTD
- Nasdaq: 2% off recent highs, +17% YTD
By mid-week last week selling was accelerating, and many investors began to believe a correction for stocks was imminent, but then the Federal Reserve gave the stock market the sugar rush it was looking for... Despite ever growing inflation concerns, the Fed made clear they were going to still be feeding the financial markets candy in the near-term. That means the Fed is continuing to monetize our debt at the same rate it has been – adding to its balance sheet which continues to pump new money supply into the markets. They also stayed firm with a near-zero percent rate policy. While it’s looking increasingly likely they’ll raise rates next year – the Fed keeping max accommodative policy in place aided in continuing to inflate stock prices, along with the prices of stuff you buy every day. In so doing, at least for last week, stock prices rallied hard to end the week flat to higher and managed to stave off a notorious September swoon. September is historically the worst month for stock market performance. With an average annual loss of nearly 1%, it’s been the most likely time for corrections (a decline of 10% or more) or even bear markets (a decline of 20% or more) to occur.
Another dynamic to watch is the crypto space. Cryptos sold off hard last week after China banned all use of non-state sponsored cryptos in the country. And speaking of government digital currency...back to the Fed for a moment. They said they’re considering rolling one out in the future. It’s early – so no indication as to when or what that might resemble – but it's clear digital currency is the future for fiat in addition to cryptos.
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: 34.75
- S&P 500 avg. P\E: 15.95
The downside risk is 54% based on earnings multiples right now from current levels. That’s flat with a week ago and it’s 11% lower than at the recent highs due to improved earnings. That’s the power of improved earnings, helping to justify stock prices which also mitigates risk. It's always important to ensure that you're positioned for negative adversity. I don’t expect anywhere near a 54% decline, however in theory it’s possible if the near worst case outcomes occurred. If a short-term decline at those levels wouldn't affect your day-to-day life, you're likely well positioned. If that is a problem for you, you should probably seek professional assistance in crafting your plan that balances your short-term needs with long term objectives.