How Low Can Stocks Go? Updated Risks & Values – October 4th, 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: 4% off recent highs, +12% YTD
- S&P 500: 4% off recent highs, +16% YTD
- Nasdaq: 5% off recent highs, +13% YTD
A strong rally to finish the week still wasn’t enough to ward off the worst week for stocks since February along with September, having once again earned its reputation as generally being a losing month for stocks. While October has historically been a better month for stocks, it’s also given birth to three of the four biggest bear market declines in US stock market history (1929, 1987, 2008). And the headwinds are many. Stocks are historically pricey, the market’s been supported by the Federal Reserve keeping the sugar rush going by continuing to flood the financial markets with easy money policy – which contributes to inflation, which is of a course a concern for you and me. There are continuing supply chain concerns throughout the economy, ongoing labor shortages which are only being complicated by select employers firing unvaccinated employees. Oh right, and whatever the heck is happening in Congress, if something happens could include massive tax increases for individuals and businesses alike. If it sounds like I’m pessimistic, I’m not - just realistic - that there’s a lot out there that could lead to a correction this month. There’s one big reason you can hang onto optimism if you’d like. Earnings. In the end it all comes back to earnings. Analysts have actually raised estimates over the past couple of months by about another 3%. That helps considerably.
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: 33.99
- S&P 500 avg. P\E: 15.95
The downside risk is 53% based on earnings multiples right now from current levels. That’s 1% less risk than a week ago and it’s 12% 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 53% 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.