This story is meant 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:
- DOW: 21% off record high
- S&P 500: 19% off record high
- Nasdaq: 17% off record high
Stocks were up about 3% across the board over the past week and after a second consecutive week of rallies, including one of the best weeks for stocks on record, the S&P 500 and Nasdaq are now officially out of bear market territory. All indices are back into bull market mode after having rallied greater than 20% from the lows. Has the market gotten ahead of itself anticipating a quick end to the worst of the economic impact of the coronavirus, or will we really be back on track by June? That’s essentially what the market has priced in at this point. It’s early to know with certainty but whatever clarity there is to be gained by corporate America is about to be on full display with earnings season set to kickoff. While I’ve wanted to be a believer in a quick turnaround, I've been a bit of a skeptic in the recent rally in advance of earnings and a full understanding of what’s in store for the US economy, starting with unemployment. Are most of the layoffs over at this point or will be see a record high unemployment rate eclipsing what happened during the Great Depression? More questions than answers at this point.
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: 20.78
- S&P 500 avg. P\E: 15.79
The downside risk is 24% based on earnings multiples right now from current levels. That's 8% 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 8% this year. That might be a bit too optimistic. We’ve been close to the fourth “near worst-case” event to play out with stocks since 1900. 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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