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 follows. Re the Dow, S&P 500 & Nasdaq stand against their all-time high levels:
- DOW: 18% off record high
- S&P 500: 15% off record high
- Nasdaq: 11% off record high
The optimism for reopening is running rampant on Wall Street as stocks are out of bear market territory across the board. Earnings season has panned out a bit better than anticipated thus far, but mostly, the belief is that the worst in the pandemic is behind us and the economy will begin to improve from here. Given the trillions pumped into the financial markets by the fed, along with stimulus spending by Congress, the money has to go somewhere and much of it is finding its way into equities. This is similar to what we saw coming out of the Great Recession a decade ago with a combination of bailouts, stimulus, and QE. If it proves to be a repeat, investors will be happy with their recent investments over the long run. But the longer-term question is still about fundamentals – not blind optimism. If we hit stumbling blocks during the reopening process and/or if the economic damage is worse than currently anticipated, there's a fair amount of downside risk in the markets. Earnings follow-through will need to happen down the road.
Here’s where the markets stand year to date.
- The Dow is down 15%, the S&P 500 down 11% & the Nasdaq is down 3%
If only market fundamentals mattered here's what we'd want to consider regarding the S&P 500 for example.
- S&P 500 P\E: 20.64
- S&P 500 avg. P\E: 15.78
The downside risk is 24% based on earnings multiples right now from current levels. That's 9% less risk compared with this time last year, however, fundamentals on trailing earnings will deteriorate. The market is priced as though earnings will only drop by about 9% this year. That might be a bit too optimistic. I’d prepare for the additional 24% drop at this point with a further reevaluation as earnings begin to roll in – just in case.
It's always important to ensure that you're positioned for negative adversity. If another 24% 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.
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