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How Much Lower Can Stocks Go?

(Wednesday, March 18, 2020,  7:30 p.m. ET) — No one knows if stock prices bottomed today or if they could go lower. We do know that profits ultimately drive stock prices. So here's the picture of 2020 and 2021 profit expectations in the context of recent market panics.

Significantly, the virus crisis currently prices stocks at a 12.3 multiple of earnings expected for 2021. Every $1 of profits expected to be earned in 2021 currently accounts for $12.30 of the average Standard & Poor's 500 company's share price. How does this compare to market panics in the recent past?

After the world financial system nearly collapsed in 2008, stocks in the first quarter of 2009 traded at 9.5 times their expected 2010 earnings. That was a more frightening crisis, however, because the worst case scenario of the pandemic can be statistically modeled and its financial economic effects can be estimated. However, the end of the world financial system has no statistical basis for measurement. It posed a bigger risk.

The 12.3 price-earnings multiple on 2021 earnings is much lower than the low reached during the market selloff of June 2015 through June 2016, when Chinese growth slowed, oil prices plunged, Brexit threatened the Europe Union, and Greece defaulted on its debt. As scary as that period was, the p-e multiple dropped only to 15.3 times second-quarter 2017 earnings versus the 12.3 multiple on earnings expected in 2021.

The dotted red line shows the recent price of the S&P 500 is sharply undervalued compared to the earnings expected in 2021. The price of the S&P 500 would have to rise sharply if earnings at the end of 2021 come in as expected. This is not a forecast or prediction, but it is what the numbers show.

The price-earnings multiples on the S&P 500 are based 2019's actual earnings of $163.00 per share, and estimates for 2020 earnings of $172.90, and $193.72 for 2021, according to data from Yardeni Research, Inc. and Thomson Reuters I/B/E/S for actual and estimated operating earnings from 2015, as well as Standard and Poor's for actual operating earnings data through 2014 and stock index pricing data through March 12, 2020.

Even if 2020 is much worse than expected by Wall Street analysts, stock valuations are near an all-time low in modern history.

The Standard & Poor's 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. It is a market-value weighted index with each stock's weight proportionate to its market value. Index returns do not include fees or expenses. Investing involves risk, including the loss of principal, and past performance is no guarantee of future results. The investment return and principal value of an investment will fluctuate so that an investor's shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than the performance quoted.

Nothing contained herein is to be considered a solicitation, research material, an investment recommendation, or advice of any kind, and it is subject to change without notice. It does not take into account your investment objectives, financial situation, or particular needs. Product suitability must be independently determined for each individual investor.

This material represents an assessment of the market and economic environment at a specific point in time and is not intended to be a forecast of future events or a guarantee of future results. Forward-looking statements are subject to certain risks and uncertainties. Actual results, performance, or achievements may differ materially from those expressed or implied. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete, and is not intended to be used as a primary basis for investment decisions.

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This article was written by a professional financial journalist for Vantage Point Financial Services, LLC and is not intended as legal or investment advice.

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