The S&P 500 is probably going to ascertain a tenth correction within the near term before the market continues, consistent with Morgan Stanley’s chief investment officer.
The benchmark index saw its first 10% correction within the new market in September — after breaking 3,500, it quickly retreated, Last week, the S&P 500 attempted to interrupt through 3,550 but failed, a symbol that the correction that began in September isn’t over.
The S&P 500 is an index of 500 US stocks that covers roughly 80% of the available US market capitalization. It is one of the oldest and best-known stock indexes in the world. the S&P indices website says that there are 3.4 trillion US dollars. Indexed to the S&P 500. that is 3.4 trillion US dollars invested in index funds that are tracking the S&P 500 index, that is a lot of money invested in the S&P 500.
The S&P 500 is an index that’s compiled of the 500 kind of biggest stocks there are in the marketplace and basically people use it as a measure of how the stock market is doing in general. Now in fact it’s very important for mutual fund managers because their performance is compared to the S&P 500.
So if the S&P 500 as an index or the market goes down 40% like it did in 2009 and a fund manager only goes down 35% in other words he only loses a third of your money instead of 40% of your money.
He gets a raise because they’re related. Their performance is related or a relative performance to the S&P 500. But that’s not how we play. Rule 1 investors are about what’s called absolute return. We don’t compare ourselves to any index.
We just want to know how much money are we making on our money every year. If we’re making 20 to 25 percent a year we don’t care if the S&P 500 is up 30 percent or down 10 percent. We’re just making money. So rule 1 investing focuses on absolute returns the market indexes are about relative returns
Investing in the S&P 500 has worked out really well from 1980 through May 2019. the S&P 500 index has on average beaten the crisp 110 US total market index while also being less volatile. The S&P 500 is synonymous with index investing.
There have to be a ton of people out there who refer to themselves as index investors while only investing in the S&P 500. One of the most compelling arguments for investing in the S&P 500 is its past performance.
The risk adjusted performance especially since the end of the financial crisis has been staggering. By staggering I mean almost impossibly good Jarrod Kaiser the chief investment officer for Buckingham strategic wealth wrote a blog post in late 2018 where he examined the performance of the S&P 500 from march 2009 through October 2018.
He used a method called bootstrapping to show that statistically. The actual performance of the S&P 500 over that time period was almost too good to have been statistically possible. The bootstrap simulation involved taking all of the historical monthly returns for the S&P 500 from 1926 through October 2018 and then drawing out 116 monthly returns to create a return series.
That is the same length as the period from March 2009. Through October 2018 this can countless times to simulate possible outcomes using the actual historical data as a sample set in Kaisers analysis. Here an 100,000 simulated 116 month periods which he was then able to compare to the actual performance of the S&P 500 index.
His findings were unbelievable. He found that of the 100,000 bootstrap samples only 0.5 7% of them had better risk adjusted returns than what the S&P 500 actually achieved from March 2009 through October 2018.
The actual results of the index were almost outside the range of statistical possibility the main takeaway from this analysis and the point that I want to make here is that well the S&P 500 has recently produced fantastic performance.
The probability of that performance repeating itself in the future is extremely low. as always past performance does not predict future performance. But in this case we have statistical evidence to show that the likelihood of the recent past performance repeating itself is extremely low.
Further to this point the S&P 500 is a lot more actively managed than most people realize. It is not simply the 500 largest stocks in the US. It is a committee based index. The stocks that go into the index are selected by a committee of people not by some algorithm.
There are selection criteria but the ultimate decision on inclusion and exclusion for the index is made by a group of humans. The ultimate goal of this committee of humans is to build an index that represents large-cap US equity markets but there’s still a human which makes repeating the exceptional past results of the index.
The S&P 500 covers roughly 80% of the US stock market capitalization. That’s pretty good coverage by market capitalization but there are closer to 3,500 stocks that exist in the US market.
Owning 500 of the 3,500 stocks available leave substantial room for error in accessing the returns of the US stock market. Even further to that point there are many more thousands of stocks that exist globally. Owning 500 of them leads to an increased chance of missing out in the global equity premium.
We know that a small number of stocks have driven most of the wealth creation in the US and global markets over time. We also know that smaller stocks including many of the roughly 3,000 stocks that are not in the S&P 500 tend to beat larger stocks over the long term again.
Well the S&P 500 has been able to beat the US market as a whole and the global market. The likelihood of that performance persisting is low and giving up diversification can come with a hefty price.
Past performance aside, one of the most common arguments that I hear in favour of investing in the S&P 500 is that its constituents get roughly half of their revenues from outside of the US. The fact that the S&P 500 constituents have global revenue sources does not offer you the investor the benefits of global diversification.
The global market cap weighted portfolio including the US and all other countries had even lower volatility to prove this point. we can simply turn back the clock and look at the past returns of US Canadian and international stocks.
We know that the past decade has favoured US stocks in general and the S&P 500 in particular. But if we go back to the period starting in January 1970 ending June 2009 Canadian US and international stocks all had very similar returns.
The US still had a small edge but a rebalance portfolio split equally across Canadian US and international stocks 9.8 4% with lower volatility than any of the individual countries. The correlation of global stocks has increased over time which is often used as an argument against global diversification. Correlation does not tell the whole story.
Even as correlations have increased the dispersion of us and non-us stock, returns has remained wide. In other words, even though markets may tend to move more in the same direction the magnitude of those movements has continued to be very different from country to country. Meaning that there is still a substantial benefit to owning global stocks.
Short term market downturns can be driven by investors changing risk preferences or panics as some may describe it. Longer-term results are driven more by the economic performance of countries. The paper concludes as follows diversification.
Protects investors against the adverse effects of holding concentrated positions in countries with poor long-term economic performance. Let us not fail to appreciate the benefits of this protection.
We have to keep in mind that the world can change the US stock market. Currently makes up roughly 55 percent of the global market capitalization but that has not always been the case.
In 1989 Japan made up 45% of the global stock market while the US was sitting at only 29 percent from January 1989 through June 2019. Japanese stocks have returned 0.6 one percent per year on average in Canadian dollar terms and Japan now makes up roughly eight percent of the global market.
Lastly no discussion about investing in the S&P 500 or US stocks in general is complete without mentioning valuations. I’m not a market timer but it is well documented that current valuations are the best predictor of future returns. When prices are high future returns tend to be lower. The S&P 500 has a price earnings ratio of 20.5 as of June 30th 2019 while Canadian stocks are trading at 14.6 and international develop stocks are trading at 14.7.
I’m not saying that you should bet against US stocks. We know that valuations can continue to rise for a long time but betting only on the most expensive market does not seem sensible either.
I have explained that the S&P 500 is probably not the most reliable approach to capturing US stock returns despite its past performance and that the S&P 500 does not offer exposure to global stock returns even though its constituents have global revenue sources. If you are currently using the S&P 500 for your US equity allocation, it’s not the end of the world compared to an actively managed fund or a stock picking strategy.
The S&P 500 is extremely well diversified and it can be accessed for almost no cost due to the massive scale of the ETF tracking it. However, the S&P 500 is not the only index that you should own in your portfolio and it probably isn’t even the best index to own for your US stock exposure. As usual the best bet that most investors can make is a bet on the total stock market through a globally diversified portfolio of total stock market index funds.