How Low Can Stocks Go? Updated Risks & Values – October 11th, 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: 2.5% off recent highs, +14% YTD
- S&P 500: 3% off recent highs, +17% YTD
- Nasdaq: 5% off recent highs, +13% YTD
Non-tech stocks and cryptos were the story over the past week as the DOW & S&P 500 rallied off recent lows along with Bitcoin surging past $55K – the highest since early May. As investors have increasingly weighed the reality that inflation is anything but temporary in the Biden economy, there’s been a rotation away from pricy tech stocks and into more of the traditional value plays. This trend has been playing out for the better part of two months but gained momentum over the past week. This is evidenced with the S&P 500 being the best performing major index for the year now, with the Nasdaq underperforming the others.
The headwinds remain many for the financial markets. 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, in fact according to FactSet, 71% of companies are being negatively impacted by the supply chains woes. You also have ongoing labor shortages which are only being complicated by select employers firing unvaccinated employees...and then there’s whatever the heck is happening in Congress. Last week simply punting on the debt ceiling was viewed as a win by the markets.
If it sounds like I’m pessimistic, I’m not - just realistic - that there’s a lot out there that could still 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: 34.25
- S&P 500 avg. P\E: 15.95
The downside risk is 53% based on earnings multiples right now from current levels. That’s flat with 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.