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 Now I think everybody everybody is wondering when will this stock market bottom? We have seen massive violent corrections more on the downside than on the upside I mean we're talking 4% 8% 10% moves Every day for a couple weeks and it's so exhausting and I hope none of you guys are watching too closely Because it can really put a damper on your mood Unfortunately for me given I'm in finance.

I write about finance I have to look at these market moves and I do want to help you guys think about 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 So regarding a stock market bottom, nobody knows for certainty When it will be and at what level it will be but we can make some highly educated guesses and as rational Investors, which I think are all of you who've been reading and listening to financial samurai all these years It's important to educate ourselves in this time of chaos The first thing we got to do is look at history How have previous bear markets performed and then maybe we can get an idea of how this one will perform We know from history that the average bear market lasts about 17 months and corrects about 35% from the peak therefore the S&P 500 could bottom at about 2200 in 2020 or 2021 second we can look at valuations We can just look at normal PE valuations forward or current valuations.

We can look at the CAPE ratio It doesn't really matter so long as you consistently look at the valuation over time. So let's just look at PE ratio we know from history that the median PE ratio is about 15 times and when the S&P 500 was at 2530 just days ago The PE was at 19 times.

So if we see a mean reversion the S&P 500 could fall down to 2000 and that's a higher from 3386 now the final way to predict a stock market bottom is my favorite way and that's making educated estimates on Quarterly earnings percentage declines in a bear market to guess the total earnings change for the year After all the S&P 500 value is made up of its annual earnings times multiple now I want to remind you that this whole earnings estimate exercise is to help you find Entry points into when you want to invest I'm assuming all of you guys will want to continuously invest in a bear market Because history has shown that the market has always recovered whether it's in 17 months 24 months or whatnot Over a 5 10 20 year period chances are you're probably gonna be higher and making money The other reason for this exercise is to calm your nerves because right now when it feels like the whole world is ending People just go crazy and get really freaked out and just start selling everything Like you see with the US Treasury bonds people just selling selling selling They just want cash and maybe cash under the mattress of things get really really bad These things do happen and it's important to have a calm and rational head So let's go through and talk about earnings estimates with the corona virus really starting to scare folks in America since early March 2020 we can make an estimate that March earnings will decline by 100% now that is an extreme estimate But let's just do it.

Anyway, therefore just doing a little math first quarter earnings will decline by 33% For the S&P 500 now, let's make another extreme guess that the second quarter 2020 earnings will again decline by 100% due to absolute paralysis Nobody's spending any money. We're all on lockdown Grocery stores are closed.

It's just shutdown mode and survival mode not even toilet paper online is available because the world ran out Now let's make another guesstimate that third quarter 2020 earnings will decline by 30% as the economy recovers but not to its original expectation at last hand sanitizer supply becomes more readily available in stores and hoarders like that one guy in Tennessee who bought 17,700 to upsell at 10 to 20x to make a profit man I understand trying to make a profit and taking care of your family, but we're in an epidemic brother And if you're gonna gouge people because you want to make 10x to 20x.

I just don't think that's right It's probably illegal, right? And then this guy goes on the New York Times with his picture and his name and says what he's been doing He's trying to gain Sympathy from the public. I mean that has to be a sign of being a sociopath not getting what he was doing 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 Attention and so forth.

You got to kind of be careful with what you say and tell journalists because journalists know how Probably their story will be received. So just be careful what you say you could get really pummeled in the media Okay, sorry about this tangent now fourth quarter earnings. Let's talk about flat We're back to our original spending amounts, which could prove to be conservative given the phenomena of revenge spending It's quite interesting revenge spending it's happening in China right now where people were just shut out Well, they're quarantined in their apartments for two months or so And then now that they're able to go out and the stores are opening right Starbucks is opening 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 They're they want revenge for having to to be cooped up in their small apartments for so long They want to buy things to make themselves feel better. And I think that could happen in America, but we shall see now the baseline assumption is Quarterly earnings equals one where one is the market assumption of earnings It does not matter what the actual earnings numbers are folks You don't have to know that, you know, the quarter number is $42 or whatever Everything is relative in finance and I'm trying to simplify this thing for you And the other assumption is that the market trades based on expected earnings, right?

For example by the time you see the number of new coronavirus cases, you know decline drastically The stock market will probably have moved up 10 20 percent. Well, depending on how much it fell So you always got to try to think ahead of the curve this is really tough for I think most people do but I've always encouraged everybody to forecast their misery Forecast the future to try to build their wealth and also protect themselves from sadness and be happier Right, that's at the end of the bottom line is to live a good life and be happy So let's go through the numbers first quarter down 33 percent One turns into 0.67 second quarter down 100 percent one turns into zero third quarter down 30 percent one turns to 0.7 and Fourth quarter 0% change one stays at one.

So you add up these quarters you get a total of 2.37 out of 4 which means a 41 percent earnings decline and now you take that 41 percent and you chop that off the all-time high of 3386 and you get a scenario where the S&P 500 will bottom at 2000 now it's up to you to ask yourself whether these earnings assumptions are conservative Optimistic or realistic in my mind.

They're a little bit conservative even for this dire movement founder There's no way second quarter earnings will decline by a hundred percent Therefore let's make some further better educated guesses about quarterly estimates. We do know that the travel Hospitality food and entertainment industry is going to take a major hit right Airlines cruise ships Those earnings are probably gonna go down 80% maybe 90% however, the consumer discretionary sector, which is what This industry is only counts for about 10% of the S&P 500 in 2020 the largest sector weightings in the S&P 500 are technology 24% health care 14% financials 12% and communication services 11% These sectors account for more than 50% of the S&P 500 and you can see how technology would probably outperform 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 At home, you know spending money online or using, you know, zoom or whatever it is health care at 14% I think you can see a case where maybe health care earnings stay flat or maybe they go up for some companies Because we're in a global health care pandemic scare communication services similar Financials, yeah, not so good Therefore instead of forecasting a hundred percent decline in the S&P 500 earnings for the month of March Let's forecast a 50% decline and as a result First quarter 2020 earnings will decline by about 15% Now, let's forecast a realistic 70% decline in second quarter 2020 earnings as citizens realize how serious the coronavirus really is and Because we're on lockdown.

We can't do anything Although consumer spending will shift online and the utilities and health care sectors may see flat earnings. Let's just stay conservative and Then third quarter 2020. Let's forecast a 30% decline as people gradually start spending again as a number of coronavirus cases and deaths decline or at least the pace and The fourth quarter, let's just keep it flat again because I think After three quarters of spending less than normal, you're gonna see some catch-up spending Holiday season consumers are thankful to have made it through a scary time period and a bear market So in this more realistic scenario in my opinion The total earnings will be 2.85 out of 4.

So that is a 29% decline in earnings If valuations stay the same the S&P 500 will decline by roughly 29% from its peak level of 2.86 in other words under this earnings scenario the S&P 500 will bottom at around 2400 now given the S&P 500 has already declined past 2400 intraday.

It was like around 2300 it was like on March 18th a believer of this earnings model can either think the bottom is already in or We'll be buying the S&P 500 index under 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 I don't know when but I think the fear of the pandemic will fade will pass I mean, we're gonna hear more and more cases more and more deaths, unfortunately But every day you hear it you just suddenly I don't know not suddenly just eventually start getting in there just like All the deaths you hear in the news from a car accident or whatever and I'm not saying they're the same thing I'm just saying it's just the way we are We are on this hedonic treadmill where we get used to great gains and great wealth And then we when we start losing things and we start suffering we start kind of getting used to the suffering as well It's just on the up and the down we kind of adapt And I do believe that in the second half American consumers will start spending like there's no tomorrow again I mean the US consumer is a mega spender, you know, we save Four to six percent of our income.

We like to spend more than we make usually sometimes I don't know. Look at the credit card data I mean, why are people putting stuff on credit card at a 24% APR and keeping revolving credit card debt? That's crazy But you know that happens and that is going to happen again 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 Therefore I think maybe my third and fourth quarter earnings estimates of a 30% decline and no decline Might be conservative and then one of the many silver linings to emerge from the corona virus pandemic Maybe that those people who had full-time jobs and kept their full-time jobs throughout the crisis Will have more money in their savings account due to the lack of spending opportunities So with more savings, they should have more financial security They should be better prepared to weather the next black swan event They might even start practicing more sound personal finance habits and they might have more money to invest for the future another potential reason for optimism is the massive fiscal stimulus plan and the monetary stimulus plan already So the Fed is kind of I'd say 90% out of bullets, right?

They cut their Fed funds rate to 0 to 0.25% They're buying back a lot of treasuries now the federal government the fiscal stimulus It's probably where it's gonna be most effective and one of the biggest fiscal Stimuli, is that what you say stimuli is to start sending households a thousand dollar a month Checks as a form of universal basic income until the pandemics under control so maybe it's a thousand dollar or more hopefully in April and then another thousand in May and maybe it's Like a graduated level like people who make less than I don't know 65,000 get a thousand people make less than a hundred thousand get 800 People who make more than whatever it is a hundred hundred fifty two hundred thousand get nothing that that sounds logical to me and then People with kids because kids are so expensive and there's no school Might get I don't know $500 per kid who knows UBI is probably the most effective way to support Americans immediately and Directly and we got to get this done and we're gonna get a bigger Deficit as a result, but you know what the deficit who cares about the deficit now when there's a global pandemic We got to help our people who are hurting the most now and we've got to support our small businesses in our communities The one thing we can all agree on is those executives who were making mega millions Better not get any mega million bonus packages for getting bailed out this time around and another thing there's like this whole argument about no bailout packages for airlines and Cruise ships because they spend a lot of their free cash flow buying back stock and enriching the executives.

Yes I totally get that argument But these industries employ hundreds of thousands of people and if you don't bail these companies and industries out More people will suffer as a result and that's not good for the economy so obviously there has to be some kind of delicate matter where we Bail out and help the people who are most affected, you know, the hard-working Americans They're making 50 60 70 thousand 80 thousand a year the median household income Not you know, the the whatever the airline executive who has a ten million dollar bonus when you know the airline industry 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 But people these executives they don't think it's BS because money is too Too attractive too alluring to decline when it's that amount to do the right thing So I think the federal government is gonna get it right this time around. They're gonna prop up the money market funds They're gonna bail out Very very consciously and I think things gonna be better this time around And guess what folks I do admit with the whole world shutting down 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 Especially since the average decline is closer to about 32 to 35 percent Everything feels hopeless now It really does but it feels exactly like it did in 2000 I was right there on the trading desk and in 2008 and 2009 when I was in my early 30s And I had a decent amount of exposure to risk assets Everything felt hopeless.

It always feels hopeless until you see things suddenly change We also know that the market tends to overshoot on the way down Therefore it wouldn't surprise me and it shouldn't surprise you if we see closer to 2000 to 2200 bottom for the S&P 500 Mostly due to extreme fear if you look at a lot of companies man the way they are priced They're priced like they're going out of business their price like the cash on their balance sheet is gonna run out way sooner than later and It's just buh-bye.

And yes, unfortunately, there's gonna be buh-bye for many companies who are not well capitalized But I think there's gonna be companies the majority of them who are gonna survive and I think things are gonna recover Like they always do I believe we will flatten the curve with social distancing and come out of this crisis stronger than before And I believe because of the quickness of the downturn I think the positive is that it's gonna be a quick upturn given.

It's a consumer shock Where nobody wants to spend any money or nobody can spend as much money 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 Whatever. I encourage you to calculate backwards the implied earnings estimates and see if they make sense If they don't make sense, then you should take action obviously at your own risk to try to profit in Finance we call this back of the envelope calculation and I think it's effective It's an effective way to calm your mind Just like writing is an effective way to calm your mind and it's effective way to figure out when to deploy more capital on the way down now, I Personally am going to be holding my nose and buying more S&P 500 and various other stocks about 10% of my holdings are individual stocks whenever the S&P 500 is below $2,400 because I believe in the earnings model that I created 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 But don't listen to what I'm doing because my situation is different from yours Remember people have made fun of me for a couple years now that I've been too conservative with my investments My main goal has been to try to earn about a three times rate of return on the 10-year bond yield So last year when the 10-year bond yield was at Two and a half three percent.

I was trying to get a seven and a half percent to ten percent rate of return Now this year now the 10-year bond yield is only at 1% So I'm trying to get a 3% rate of return, you know, honestly, I'm trying to get more than that But I I don't have a job folks.

I don't have steady income I don't have a wife who has a full-time job or is freelancing I'm just a stay-at-home dad who's trying to make the best of things just like many of you guys So I don't have that ability to take more risk and this is why I'm spending so much time Thinking about entry points thinking about asset allocation.

I think a lot Because it's important you've got to think about your finances. Otherwise, you're gonna blow yourself up You don't want to be you know 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 Then it's just done.

So you've got to work probably five three to five more years You need to think about this and it reminds me of the situation I remember in school where the people who would raise their hand to ask question to ask the teacher to clarify Were made fun of they were made fun of by the people who didn't take things seriously We got to take this seriously folks, and this is why I will continue to write Continue to record and continue to try to slice through this chaos to help myself and help all of you guys Get a better handle of your finances.

So thanks so much everyone I appreciate you guys listening and reading and if you want to share my work subscribe to the newsletter or this podcast feel free Just spend time thinking things through Because the people who are panicking are just not thinking things through Take care everyone and wash your hands