Is the S&P500 Still Worth Buying?
Recently, I've had the unfortunate chance of discussing the S&P500 with one of my good friends, who has become acquainted with the world of investing as of late. Jokes aside, he mentioned that a friend of his said that the S&P500 would generate guaranteed returns in the long term. That thought slightly concerns me. I think it's not a stretch to say that in recent times, an unprecedented number of retail investors have entered the market, be it from the Reddit GameStop (GME) kerfuffle or simply common advice. Naturally, that results in a whole bunch of people getting thrust into the world of investing without any knowledge whatsoever, and that's okay! But it's important to ensure that common advice is not simply parroted without understanding the rationale behind it in the first place.
So, why is the S&P500 touted as a wise investment in the first place?
For those who are new, the S&P500 stands for The Standard & Poor's 500. It's a basket of the biggest 500 publicly listed US companies in terms of market capitalisation and is widely regarded as the benchmark for stock investing. Why these companies, you ask? Essentially, it boils down to the fact that the US is highly regarded as the world's biggest economic superpower, coupled with the rationale that surely, the largest market capitalisation stocks with large inflows of investment on a daily basis should be wise investments. If not, why would they be heavily invested in in the first place?
Indeed, had I written this article twenty years ago, you would probably be hollering insult after insult at me.
Evidently, investors of the S&P500, which can be done via an Exchange Traded Fund (ETF) such as VOO, have been rewarded handsomely for their patience and conviction. From 2002 to 2022, the average compounding annual return of the S&P500 was 8.19%. That's a total return of 422.68%. Not too shabby.
Historically, the S&P500 has certainly performed well, depending on the time frame that you use. If you viewed the index's performance since its conceptualisation - in 1957, you'll find that it has instead returned a staggering compounded 10.15% per year. To put that into perspective, $100 invested in 1957 is now approximately $59,000 in 2022. Yet, if you invested in 2010, you would have gotten a compounded annual return of 12.84%.
Just take a look at that sexy exponential graph, and you'll begin to see what I mean. It's hard to argue not to invest in the S&P500. In fact, the S&P500 has returned even more in recent times. Would you not sleep soundly knowing that you're vested in Coca-Cola, the world's leading soft drink distributor? What about McDonald's, that ubiquitous fast-food restaurant? Or would Procter & Gamble tickle your fancy, being the company that's probably behind your favourite cleanliness product? The fact is, investors can rest assured knowing that they're investing in successful companies with proven business models.
"So what? I could easily beat that return! In fact, I invested in Tesla early and generated triple-digit returns!" Just might be what you're saying.
Fair enough, you've beaten the market. But, could you do it in the long term? Well, statistically, most likely not. After a time frame of ten years, over 85% of large-cap funds underperformed the S&P500. We're talking about behemoth organisations with countless quants ready to trade at any given notice. What makes you think that you'll beat them? Even if you did, could you beat the broader market?
Okay, the S&P500 has done pretty well. Just funnel your cash and hold long-term, open and shut case right?
Well, if you read the title of this article, you’ll probably realise it implies that you should perhaps reconsider the above notion.
When you’re betting on the S&P500, you’re investing in 100% US equities, and that doesn’t sound geographically diversified at all… “Their revenue sources are actually from all parts of the world!” You protest, and I concur, a US-specific economic recession probably wouldn’t hurt business operations too much. But you’re not going to capture specific stock market behaviour. Dumb money does move markets. Take the recent AI craze or the previous clean energy trend. Institutional money definitely didn’t only invest just right there and then. Additionally, to add to my previous point of US equities' revenues being tied to the US, there is some research that shows a positive correlation between S&P500 returns and US Real GDP.
Source: University of Nebraska
Now, I'm not here to argue correlation equates to causation or whatnot, but you have to admit that an R-squared value of 0.92 is on the high side. That's some serious correlation... Ask yourself this question: Will the US continue to outperform the global economy? I'll use this analogy that I previously raised to my friend earlier: Consider this student, who's always achieved a mix of As and Cs throughout their years. They started with As in Primary 1, Cs in Primary 2, and so on. They've overall achieved an average grade of a B within their lifetime, but could you safely assume that such a trend will continue into Secondary School? What about Junior College? I'm not sure if this holds true universally, but I sure as hell wasn't getting straight As in JC as I did in primary school. I guess it's different in a way since education increases in difficulty throughout the years, but my point still stands. You have to admit that the US economy saw an early onset of high growth throughout the early inception of the S&P500, benefitting from massive changes to worker and infrastructure efficiency to produce higher quality goods. Could we see the S&P500's growth taper off in the near future? I know the data from 2010 challenges this theory, but it may simply be attributed to the recent tech hype, with investors throwing cash hand over fist into anything with the latest buzzword.
Not to mention, the S&P500 consists purely of mega-cap stocks which could lead to limited room for upside as compared to smaller cap stocks, so investors with a healthy risk appetite may not find that this index is suitable for their investing needs, but I digress.
Now that I've stated my case, what's the conclusion?
In my humble opinion, I don't think I'll be investing in an S&P500 ETF very much. I'd much rather take my chances with VWRA, a global ETF that holds a basket of global stocks. I'm very much comfortable with limiting my exposure to the US and instead allocate my assets to emerging economies such as India instead. Furthermore, it's not like the US has become some sort of a negligible part of VWRA, it's still around 44% in terms of weightage. Also, if you didn't know, the S&P500 offers dividends, which are taxed at around 30% if you're a Singapore resident. It's much more tax efficient to invest in an Ireland-domiciled ETF, reducing your tax to only 15%.
For those into lump sum investing or short-term trades, is the S&P500 a good buy right now?
This will be a simple analysis, but I hope to provide some sort of perspective regarding the S&P500's current valuations. It's no secret that Jerome Powell, head of the Fed, has recently released a slew of interest rate hikes in order to tackle inflation. As of right now, I don't think the rate hikes are enough, and we may see a second onslaught of inflation. It seems like the labour market is still remaining strong, and that's bad news for Powell. If he does indeed go in the footsteps of Volcker, then the interest rate hikes right now are just the beginning. I don't think there'll be a soft landing, which leaves only one of two scenarios to materialise.
1. Interest rates remain relatively low and inflation runs rampant.
2. Interest rates become too high, resulting in an economic recession.
Neither seems like a desirable outcome for equities as a whole.
According to Multpl, the historic PE ratio of the S&P500 is 15.99, a good bit lower than the current 21.8. Furthermore, PE ratio is a lagging metric. Should the economy experience a downturn, what do you think will happen when earnings reports come out? A bloodbath will ensue. This hasn't even accounted for the potential higher operating costs from interest payments due to rate hikes.
Hence, I'll be staying away from the S&P500 as of now. I'll take a look when things start to cool down, but I think there are plenty of buying opportunities in the SG market right now, which includes certain counters that I've covered previously. That being said, don't let this article stop you from investing in a well-known index with a proven track record of great returns, just try to understand what you're actually investing in (I'm talking as if I know what I'm investing in).
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