How low can stocks go? Updated risks and values – January 12th

How low can stocks go? Updated risks and values – January 12th

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. This week's edition of "how low can stocks go" goes as the Dow, S&P 500 & Nasdaq stand against their all-time high levels:

  • DOW: within 1%
  • S&P 500: within 1%
  • Nasdaq: 1% off record highs

We’re in a weird zone right now for stocks. On one hand we have a Biden administration which has called for tax increases - including specifically tax increases on investment, regulation increases and has nominated a Bernie Sanders approved candidate for Labor Secretary. In a normal world there might be a full-fledged freak out taking place in the markets with the potential that even some of that agenda could occur. However, we’re in the altered state of COVID-19 reality where the Biden administration is also saying there will be yet another round of stimulus to the tune of trillions of dollars. The reality of free candy and puppies for all (paid for by taxpayer funded debt) is a short term sugar rush for the market. Should that reality hit quickly, which is likely, that debt spent money will enter the economy and boost the bottom lines for many companies. For now, the sugar rush is generally winning the day over the potential for massive negative policy changes for businesses and investors.

Here’s where the market stands based on fundamentals using the S&P 500 as the example.

  • S&P 500 P\E: 38.29
  • S&P 500 avg. P\E: 15.87

The downside risk is 59% based on earnings multiples right now from current levels. That's 21% more risk compared with this time last year. The market is historically expensive right now. Stocks are priced for an earnings rebound in 2021. It’s mostly like this. If the economy does recover as expected stock prices can be justified. If there’s a double-dip recession – hold your butt. There’s a lot of room for downside. That’s basically where we are right now.

It's always important to ensure that you're positioned for negative adversity. If a 59% 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.

Photo Credit: Getty Images