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How Low Can Stocks Go? Updated Risks & Values – October 25th, 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: All-time high, +17% YTD
- S&P 500: within 1% of recent highs, +21% YTD
- Nasdaq: 2% off recent highs, +17% YTD
It’s all been about earnings. They’ve been nothing short of phenomenal as we’re closing in on a quarter of companies having reported for the 3rd quarter. They’ve led the DOW to an all-time high and placed the other indexes within a good day of reaching them as well. The other huge implication has been a significant reduction in risk. It’s no secret that stocks have been super pricey generally over much of the past year. And while they’re certainly not cheap at these prices, they are much cheaper despite the powerful rally we’ve seen the past couple of weeks because earnings have risen well above expectations.
With 23% of companies having reported, 84% of companies have exceeded expectations and the average beat has been meaningful – 13% above expectations. If this holds it’ll be the third best earnings season relative to expectations on record. The other huge storyline has been cryptos. Led by a new ETF debuting last week allowing typical equity investors an opportunity to invest in cryptos without having to directly own them, we saw Bitcoin surge to record highs mid-week before settling in just below $60,000 by the end of it. The next step in the mainstreaming of them happened last week. That may have the potential to represent a near-term peak in prices, as there aren’t necessarily other huge catalysts right around the corner. Now about the brass tax.
As we enter this week here’s where the market stands based on fundamentals using the S&P 500 as the example.
- S&P 500 P\E: 28.63
- S&P 500 avg. P\E: 15.95
The downside risk is 44% based on earnings multiples right now from current levels. That’s one percent more risk than a week ago, however it’s 11% lower than at the recent highs due to improved earnings. That’s the power of improved earnings, helping to justify stock prices which also mitigates risk. It's always important to ensure that you're positioned for negative adversity. I don’t expect anywhere near a 44% 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.