How Low Can Stocks Go? Jan. 4th, 2021

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. The Dow, S&P 500 & Nasdaq stand against their all-time high levels:

  • DOW: within 1%
  • S&P 500: within 1%
  • Nasdaq: within 1%

What a year 2020 was for stocks! It encompassed every aspect of why I’ve provided this weekly update since the Great Recession over a decade ago. We had a pandemic induced crash which gave way to double-digit gains for the market overall in 2020. In fact, the S&P 500 ended the year 71% higher than the lowest levels reached during the crash. If you were driven by emotions rather than pragmatism, you might have been inclined to sell near the lows and might be buying again at these record-high levels. Having a consistent plan driven by pragmatism rather than emotion is key.

As we enter the new year here’s where the market stands based on fundamentals using the S&P 500 as an example.

  • S&P 500 P\E: 37.85
  • S&P 500 avg. P\E: 15.87

The downside risk is 58% based on earnings multiples right now from current levels. That's 20% more risk compared with this time last year. The market is historically expensive right now. Stocks are priced for solid earnings rebound in 2021. 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 58% 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 by: Getty Images

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