How Low Can Stocks Go? Updated Risks & Values – October 18th, 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: 1% off recent highs, +17% YTD
- S&P 500: 2% off recent highs, +20% YTD
- Nasdaq: 3% off recent highs, +15% YTD
Stocks rallied hard across the board last week predominately due to the onset of earnings season being absolutely awesome. After the second quarter earnings season proved to be one of the top two on record as companies smashed through expectations at a record setting pace. It was thought the 3rd quarter would be the one that might see companies struggling under the weight of inflation, labor shortages and severe supply chain disruption. Those factors are all very real but what’s been clear so far is that larger companies have successfully passed on the price increases to us while managing well through the supply chain problems. The same isn’t likely true of smaller businesses that may not have the wherewithal to navigate these challenges so easily. So once again we’re likely in an environment that’s especially good for large companies often at the expense of smaller businesses.
Through Friday, 8% of companies had reported earnings with 80% reporting above expectations – the third highest on record. And it’s not just that companies are exceeding earnings expectations, they’re continuing to smash them with the average beat being by 15%. So yes, earnings are awesome and stocks are once again reflecting this. The other huge news in the financial markets pertained to Bitcoin. US regulators greenlighted a cryptocurrency ETF for the first time which will allow traditional equity investors to easily gain access to investing in cryptos without having to personally hold them. As a result, Bitcoin surged past $60,000 – ending the week at a record high.
As we enter this week here’s where the market stands based on fundamentals using the S&P 500 as the example.
The downside risk is 43% based on earnings multiples right now from current levels. That’s 10% less risk than a week ago and it’s 22% lower than highs reached earlier this year. This illustrates the power of improved earnings. As earnings improve, they help justify stock prices which also mitigates risk. It’s rather remarkable that last week marked a huge rally for the markets and yet risk dropped by 10% on a fundamental basis at the same time. That’s exiting. It's always important to ensure that you're positioned for negative adversity. I don’t expect anywhere near a 43% 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.