Predicting_A_Stock_Market_Bottom
00:00:00.000 | Hello everybody, it's Sam from Financial Samurai and in this episode we're gonna talk about how to predict a stock market bottom like Nostradamus
00:00:08.020 | Now I think everybody everybody is wondering when will this stock market bottom?
00:00:14.760 | We have seen massive violent corrections more on the downside than on the upside
00:00:21.060 | I mean we're talking 4% 8% 10% moves
00:00:25.500 | Every day for a couple weeks and it's so exhausting and I hope none of you guys are watching too closely
00:00:32.240 | Because it can really put a damper on your mood
00:00:36.040 | Unfortunately for me given I'm in finance. I write about finance
00:00:40.180 | I have to look at these market moves and I do want to help you guys think about
00:00:44.980 | How to invest for the future and I also want to help you guys calm your nerves if you're feeling a little bit jerry
00:00:51.380 | So regarding a stock market bottom, nobody knows for certainty
00:00:55.940 | When it will be and at what level it will be but we can make some highly educated guesses and as rational
00:01:04.420 | Investors, which I think are all of you who've been reading and listening to financial samurai all these years
00:01:10.220 | It's important to educate ourselves in this time of chaos
00:01:14.180 | The first thing we got to do is look at history
00:01:17.220 | How have previous bear markets performed and then maybe we can get an idea of how this one will perform
00:01:23.660 | We know from history that the average bear market lasts about 17 months and corrects about
00:01:29.260 | 35% from the peak
00:01:31.980 | therefore the S&P 500
00:01:33.980 | could bottom at about
00:01:36.380 | 2200 in
00:01:37.860 | 2020 or 2021 second we can look at valuations
00:01:42.220 | We can just look at normal PE valuations forward or current valuations. We can look at the CAPE ratio
00:01:48.900 | It doesn't really matter so long as you consistently look at the valuation over time. So let's just look at
00:01:54.960 | PE ratio
00:01:57.060 | we know from history that the median PE ratio is about 15 times and when the S&P 500 was at
00:02:04.220 | 2530 just days ago
00:02:07.780 | The PE was at 19 times. So if we see a mean reversion
00:02:12.020 | the S&P 500 could fall down to
00:02:15.900 | 2000 and that's a higher from
00:02:18.500 | 3386 now the final way to predict a stock market bottom is my favorite way and that's making educated estimates on
00:02:26.740 | Quarterly earnings percentage declines in a bear market to guess the total earnings change for the year
00:02:34.060 | After all the S&P 500 value is made up of its annual earnings times multiple now
00:02:40.340 | I want to remind you that this whole earnings estimate exercise is to help you find
00:02:46.020 | Entry points into when you want to invest I'm assuming all of you guys will want to continuously invest in a bear market
00:02:53.820 | Because history has shown that the market has always recovered whether it's in 17 months 24 months or whatnot
00:03:00.660 | Over a 5 10 20 year period chances are you're probably gonna be higher and making money
00:03:06.420 | The other reason for this exercise is to calm your nerves because right now when it feels like the whole world is ending
00:03:13.100 | People just go crazy and get really freaked out and just start selling everything
00:03:18.260 | Like you see with the US Treasury bonds people just selling selling selling
00:03:22.060 | They just want cash and maybe cash under the mattress of things get really really bad
00:03:27.020 | These things do happen and it's important to have a calm and rational head
00:03:31.940 | So let's go through and talk about earnings estimates with the corona virus really starting to scare folks in America since early March
00:03:39.780 | 2020 we can make an estimate that March earnings will decline by 100% now that is an extreme estimate
00:03:48.040 | But let's just do it. Anyway, therefore just doing a little math first quarter earnings will decline by 33%
00:03:55.020 | For the S&P 500 now, let's make another extreme guess that the second quarter 2020 earnings will again decline by
00:04:02.220 | 100% due to absolute paralysis
00:04:04.980 | Nobody's spending any money. We're all on lockdown
00:04:08.420 | Grocery stores are closed. It's just shutdown mode and survival mode not even toilet paper online is available because the world ran out
00:04:18.020 | Now let's make another guesstimate that third quarter 2020 earnings will decline by 30% as the economy recovers
00:04:25.220 | but not to its original expectation at last hand sanitizer supply becomes more readily available in stores and
00:04:32.900 | hoarders like that one guy in Tennessee who bought
00:04:35.960 | 17,700 to upsell at 10 to 20x to make a profit man
00:04:41.380 | I understand trying to make a profit and taking care of your family, but we're in an epidemic brother
00:04:48.020 | And if you're gonna gouge people because you want to make 10x to 20x. I just don't think that's right
00:04:55.060 | It's probably illegal, right?
00:04:56.180 | And then this guy goes on the New York Times with his picture and his name and says what he's been doing
00:05:02.340 | He's trying to gain
00:05:03.620 | Sympathy from the public. I mean that has to be a sign of being a sociopath not getting what he was doing
00:05:11.780 | Was wrong or probably not going to be looked favorably among and this is something else for folks of you who want to get media
00:05:18.880 | Attention and so forth. You got to kind of be careful with what you say and tell journalists because journalists know how
00:05:27.220 | Probably their story will be received. So just be careful what you say you could get really pummeled in the media
00:05:35.700 | Okay, sorry about this tangent now fourth quarter earnings. Let's talk about flat
00:05:40.620 | We're back to our original spending amounts, which could prove to be conservative given the phenomena of revenge spending
00:05:46.660 | It's quite interesting revenge spending it's happening in China right now where people were just shut out
00:05:52.580 | Well, they're quarantined in their apartments for two months or so
00:05:55.940 | And then now that they're able to go out and the stores are opening right Starbucks is opening
00:06:01.020 | The fancy malls are opening everything is back to almost normal in China. They're spending their catch-up spending and they're spending like no tomorrow
00:06:07.980 | They're they want revenge for having to to be cooped up in their small apartments for so long
00:06:13.280 | They want to buy things to make themselves feel better. And I think that could happen in America, but we shall see
00:06:18.560 | now the baseline assumption is
00:06:22.100 | Quarterly earnings equals one where one is the market assumption of earnings
00:06:27.000 | It does not matter what the actual earnings numbers are folks
00:06:30.660 | You don't have to know that, you know, the quarter number is $42 or whatever
00:06:36.340 | Everything is relative in finance and I'm trying to simplify this thing for you
00:06:40.140 | And the other assumption is that the market trades based on expected earnings, right?
00:06:45.020 | For example by the time you see the number of new coronavirus cases, you know decline drastically
00:06:51.100 | The stock market will probably have moved up 10 20 percent. Well, depending on how much it fell
00:06:56.940 | So you always got to try to think ahead of the curve
00:06:59.540 | this is really tough for I think most people do but I've always encouraged everybody to
00:07:05.140 | forecast their misery
00:07:07.140 | Forecast the future to try to build their wealth and also protect themselves from sadness and be happier
00:07:12.820 | Right, that's at the end of the bottom line is to live a good life and be happy
00:07:15.500 | So let's go through the numbers first quarter down 33 percent
00:07:19.380 | One turns into 0.67 second quarter down 100 percent one turns into zero
00:07:25.900 | third quarter down 30 percent one turns to 0.7 and
00:07:30.580 | Fourth quarter 0% change one stays at one. So you add up these quarters you get a total of
00:07:37.200 | 2.37 out of 4 which means a 41 percent earnings decline and now you take that 41 percent and you chop that off
00:07:45.780 | the all-time high of
00:07:47.780 | 3386 and you get a scenario where the S&P 500 will bottom at
00:07:52.160 | 2000 now it's up to you to ask yourself whether these earnings assumptions are conservative
00:07:59.820 | Optimistic or realistic in my mind. They're a little bit conservative even for this dire movement founder
00:08:07.680 | There's no way second quarter earnings will decline by a hundred percent
00:08:11.060 | Therefore let's make some further better educated guesses about quarterly estimates. We do know that the travel
00:08:17.540 | Hospitality food and entertainment industry is going to take a major hit right Airlines
00:08:22.820 | cruise ships
00:08:24.780 | Those earnings are probably gonna go down 80% maybe 90%
00:08:28.540 | however, the consumer discretionary sector, which is what
00:08:31.560 | This industry is only counts for about 10% of the S&P 500 in 2020
00:08:36.780 | the largest sector weightings in the S&P 500 are
00:08:40.260 | technology 24% health care 14% financials 12% and
00:08:45.940 | communication services 11%
00:08:48.660 | These sectors account for more than 50% of the S&P 500 and you can see how technology would probably outperform
00:08:56.740 | Probably because technology is kind of what drives the world and it's not as if technology will be shut down if you're at home
00:09:03.980 | At home, you know spending money online or using, you know, zoom or whatever it is health care at 14%
00:09:10.620 | I think you can see a case where maybe health care earnings stay flat or maybe they go up for some companies
00:09:16.040 | Because we're in a global health care pandemic scare
00:09:20.340 | communication services similar
00:09:23.180 | Financials, yeah, not so good
00:09:25.820 | Therefore instead of forecasting a hundred percent decline in the S&P 500 earnings for the month of March
00:09:31.100 | Let's forecast a 50% decline and as a result
00:09:34.660 | First quarter 2020 earnings will decline by about 15%
00:09:38.300 | Now, let's forecast a realistic
00:09:41.340 | 70% decline in second quarter 2020 earnings as citizens realize how serious the coronavirus really is and
00:09:48.620 | Because we're on lockdown. We can't do anything
00:09:51.740 | Although consumer spending will shift online and the utilities and health care sectors may see flat earnings. Let's just stay conservative and
00:09:59.700 | Then third quarter 2020. Let's forecast a 30% decline as people gradually start spending again as a number of
00:10:07.620 | coronavirus cases and deaths decline or at least the pace and
00:10:11.140 | The fourth quarter, let's just keep it flat again because I think
00:10:15.260 | After three quarters of spending less than normal, you're gonna see some catch-up spending
00:10:21.500 | Holiday season consumers are thankful to have made it through a scary time period and a bear market
00:10:26.940 | So in this more realistic scenario in my opinion
00:10:30.740 | The total earnings will be 2.85 out of 4. So that is a 29% decline in earnings
00:10:38.780 | If valuations stay the same the S&P 500 will decline by roughly 29% from its peak level of
00:10:46.500 | 2.86 in other words under this earnings scenario the S&P 500 will bottom at around
00:10:52.600 | 2400 now given the S&P 500 has already declined past 2400 intraday. It was like around
00:10:58.800 | 2300 it was like on March 18th a believer of this earnings model can either think the bottom is already in or
00:11:06.700 | We'll be buying the S&P 500 index under
00:11:11.180 | 2400 again personally, I think there's gonna be closer to a v-shape recovery in demand at some time during the second half of 2020
00:11:18.060 | I don't know when but I think the fear of the pandemic will fade will pass
00:11:24.020 | I mean, we're gonna hear more and more cases more and more deaths, unfortunately
00:11:28.180 | But every day you hear it you just suddenly I don't know not suddenly just eventually start getting in there just like
00:11:34.500 | All the deaths you hear in the news from a car accident or whatever and I'm not saying they're the same thing
00:11:40.340 | I'm just saying it's just the way we are
00:11:42.500 | We are on this hedonic treadmill where we get used to great gains and great wealth
00:11:47.820 | And then we when we start losing things and we start suffering we start kind of getting used to the suffering as well
00:11:55.000 | It's just on the up and the down we kind of adapt
00:11:57.660 | And I do believe that in the second half American consumers will start spending like there's no tomorrow again
00:12:03.540 | I mean the US consumer is a mega spender, you know, we save
00:12:08.140 | Four to six percent of our income. We like to spend more than we make usually sometimes
00:12:14.280 | I don't know. Look at the credit card data
00:12:16.380 | I mean, why are people putting stuff on credit card at a 24% APR and keeping revolving credit card debt?
00:12:22.980 | That's crazy
00:12:24.460 | But you know that happens and that is going to happen again
00:12:28.020 | And I think you just can't count out how much we consume how much we eat how much we consume or whatever it is
00:12:34.580 | Therefore I think maybe my third and fourth quarter earnings estimates of a 30% decline and no decline
00:12:41.300 | Might be conservative and then one of the many silver linings to emerge from the corona virus pandemic
00:12:48.420 | Maybe that those people who had full-time jobs and kept their full-time jobs throughout the crisis
00:12:54.940 | Will have more money in their savings account due to the lack of spending opportunities
00:12:59.260 | So with more savings, they should have more financial security
00:13:03.460 | They should be better prepared to weather the next black swan event
00:13:07.180 | They might even start practicing more sound personal finance habits and they might have more money to invest for the future
00:13:15.780 | another potential reason for optimism is the massive
00:13:19.980 | fiscal stimulus plan and the monetary stimulus plan already
00:13:25.380 | So the Fed is kind of I'd say 90% out of bullets, right?
00:13:29.060 | They cut their Fed funds rate to 0 to 0.25%
00:13:33.340 | They're buying back a lot of treasuries now the federal government the fiscal stimulus
00:13:39.460 | It's probably where it's gonna be most effective and one of the biggest fiscal
00:13:43.780 | Stimuli, is that what you say stimuli is to start sending households a thousand dollar a month
00:13:50.020 | Checks as a form of universal basic income until the pandemics under control
00:13:55.020 | so maybe it's a thousand dollar or more hopefully in April and then another thousand in May and maybe it's
00:14:03.020 | Like a graduated level like people who make less than I don't know
00:14:07.820 | 65,000 get a thousand people make less than a hundred thousand get 800
00:14:11.740 | People who make more than whatever it is
00:14:14.340 | a hundred hundred fifty two hundred thousand get nothing that that sounds logical to me and then
00:14:19.500 | People with kids because kids are so expensive and there's no school
00:14:23.100 | Might get I don't know
00:14:26.900 | $500 per kid who knows UBI is probably the most effective way to support Americans immediately and
00:14:32.460 | Directly and we got to get this done and we're gonna get a bigger
00:14:35.820 | Deficit as a result, but you know what the deficit who cares about the deficit now when there's a global pandemic
00:14:42.260 | We got to help our people who are hurting the most now and we've got to support our small businesses in our communities
00:14:49.300 | The one thing we can all agree on is those executives who were making mega millions
00:14:54.700 | Better not get any mega million bonus packages for getting bailed out this time around and another thing
00:15:01.540 | there's like this whole argument about no bailout packages for airlines and
00:15:06.420 | Cruise ships because they spend a lot of their free cash flow buying back stock and enriching the executives. Yes
00:15:12.500 | I totally get that argument
00:15:14.380 | But these industries employ hundreds of thousands of people and if you don't bail these companies and industries out
00:15:20.980 | More people will suffer as a result and that's not good for the economy
00:15:25.700 | so obviously there has to be some kind of delicate matter where we
00:15:28.260 | Bail out and help the people who are most affected, you know, the hard-working Americans
00:15:33.900 | They're making 50 60 70 thousand 80 thousand a year the median household income
00:15:37.940 | Not you know, the the whatever the airline executive who has a ten million dollar bonus when you know the airline industry
00:15:46.340 | Artificially propped up its share price and then underperform the S&P 500 by 10% I mean that's come on. Everybody knows that's BS
00:15:53.800 | But people these executives they don't think it's BS because money is too
00:16:01.100 | Too attractive too alluring to decline when it's that amount to do the right thing
00:16:06.780 | So I think the federal government is gonna get it right this time around. They're gonna prop up the money market funds
00:16:12.060 | They're gonna bail out
00:16:13.980 | Very very consciously and I think things gonna be better this time around
00:16:18.420 | And guess what folks I do admit with the whole world shutting down
00:16:23.060 | It's very hard for me to believe that 2400 or a 29% decline in the S&P 500 marks the bottom of this bear market
00:16:30.740 | Especially since the average decline is closer to about 32 to 35 percent
00:16:34.700 | Everything feels hopeless now
00:16:37.340 | It really does but it feels exactly like it did in 2000
00:16:41.580 | I was right there on the trading desk and in 2008 and 2009 when I was in my early 30s
00:16:47.600 | And I had a decent amount of exposure to risk assets
00:16:51.620 | Everything felt hopeless. It always feels hopeless
00:16:54.700 | until you see
00:16:56.900 | things suddenly change
00:16:59.220 | We also know that the market tends to overshoot on the way down
00:17:02.660 | Therefore it wouldn't surprise me and it shouldn't surprise you if we see closer to 2000 to 2200
00:17:08.840 | bottom for the S&P 500
00:17:11.420 | Mostly due to extreme fear if you look at a lot of companies man the way they are priced
00:17:16.900 | They're priced like they're going out of business
00:17:19.100 | their price like the cash on their balance sheet is gonna run out way sooner than later and
00:17:25.460 | It's just buh-bye. And yes, unfortunately, there's gonna be buh-bye for many companies who are not well capitalized
00:17:33.540 | But I think there's gonna be companies the majority of them who are gonna survive and I think things are gonna recover
00:17:39.780 | Like they always do I believe we will flatten the curve with social distancing and come out of this crisis stronger than before
00:17:47.340 | And I believe because of the quickness of the downturn
00:17:52.360 | I think the positive is that it's gonna be a quick upturn given. It's a consumer shock
00:17:57.560 | Where nobody wants to spend any money or nobody can spend as much money
00:18:02.180 | So wherever the S&P 500 is when you listen to this podcast, it doesn't matter when it could be in 2020 2025 2030
00:18:10.660 | Whatever. I encourage you to calculate backwards the implied earnings estimates and see if they make sense
00:18:17.940 | If they don't make sense, then you should take action obviously at your own risk to try to profit in
00:18:24.420 | Finance we call this back of the envelope calculation and I think it's effective
00:18:29.100 | It's an effective way to calm your mind
00:18:31.540 | Just like writing is an effective way to calm your mind and it's effective way to figure out when to deploy more
00:18:38.260 | capital on the way down now, I
00:18:40.980 | Personally am going to be holding my nose and buying more
00:18:45.660 | S&P 500 and various other stocks about 10% of my holdings are individual stocks whenever the S&P 500 is below
00:18:52.740 | $2,400 because I believe in the earnings model that I created
00:18:57.700 | So if you would call me Nostradamus, I'm gonna say the bottom of the S&P 500 is 23 to 2400 and I'm a buyer
00:19:06.060 | But don't listen to what I'm doing because my situation is different from yours
00:19:10.700 | Remember people have made fun of me for a couple years now that I've been too conservative with my investments
00:19:16.700 | My main goal has been to try to earn about a three times rate of return on the 10-year bond yield
00:19:23.620 | So last year when the 10-year bond yield was at
00:19:26.380 | Two and a half three percent. I was trying to get a seven and a half percent to ten percent rate of return
00:19:30.600 | Now this year now the 10-year bond yield is only at 1%
00:19:34.140 | So I'm trying to get a 3% rate of return, you know, honestly, I'm trying to get more than that
00:19:38.820 | But I I don't have a job folks. I don't have steady income
00:19:42.860 | I don't have a wife who has a full-time job or is freelancing
00:19:46.380 | I'm just a stay-at-home dad who's trying to make the best of things just like many of you guys
00:19:51.860 | So I don't have that ability to take more risk and this is why I'm spending so much time
00:19:57.180 | Thinking about entry points thinking about asset allocation. I think a lot
00:20:03.500 | Because it's important you've got to think about your finances. Otherwise, you're gonna blow yourself up
00:20:09.140 | You don't want to be you know
00:20:11.220 | the person who's gonna be retiring in the next three years with 80 90 100 percent of their net worth in the equity market and
00:20:18.660 | Then it's just done. So you've got to work probably five three to five more years
00:20:24.180 | You need to think about this and it reminds me of the situation
00:20:28.420 | I remember in school where the people who would raise their hand to ask question to ask the teacher to clarify
00:20:33.900 | Were made fun of they were made fun of by the people who didn't take things seriously
00:20:38.780 | We got to take this seriously folks, and this is why I will continue to write
00:20:43.940 | Continue to record and continue to try to slice through this chaos to help myself and help all of you guys
00:20:50.980 | Get a better handle of your finances. So thanks so much everyone
00:20:55.380 | I appreciate you guys listening and reading and if you want to share my work subscribe to the newsletter or this podcast feel free
00:21:02.060 | Just spend time thinking things through
00:21:05.060 | Because the people who are panicking are just not thinking things through
00:21:09.620 | Take care everyone and wash your hands