My approach is to invest in individual companies. But with the S&P 500 at record highs, I can certainly see the appeal of index funds. They’d eliminate the need for me to research and monitor specific stocks.
Even Warren Buffett says passive investing is a solid strategy. Indeed, he said Jack Bogle, the father of index funds, had “probably done more for the American investor than any man in the country“.
The S&P 500 measures the performance of the 500 largest American companies. Today, it’s dominated by tech titans like Microsoft, Apple, and Nvidia.
Here, I’ll look at how much I’d have now if I’d invested £5,000 in an S&P 500 exchange-traded fund (ETF) at the start of the year.
Some were bearish
Heading into 2024, some market watchers weren’t bullish on the index’s prospects. For example, Marko Kolanovic, who was then JP Morgan‘s chief global markets strategist, predicted “another challenging year for market participants“.
For the S&P 500, the investment bank estimated earnings growth of 2–3% and a price target of 4,200 points, with a “downside bias“.
Given that the index started the year at 4,769, that wouldn’t have been a great investment.
What’s happened so far?
However, the S&P 500’s historically returned just over 10% annually with dividends reinvested. And it’s gone up two out of every three years on average.
Like Man City or Real Madrid, it tends to win more than it loses. That’s why passive investing works and is so popular.
Year to date, the S&P 500’s rocketed just over 20%. This means my £5k investment would now be worth £6k on paper. Add with another 1.3% expected from dividends, that’s a cracking return.
Of course, the year isn’t over yet. The S&P 500 could always fall sharply from this point.
A high price to pay
That risk is heightened because the US market’s currently very expensive.
Take the S&P 500’s Shiller P/E ratio (or cyclically adjusted price-to-earnings ratio). This compares the index’s price to its inflation-adjusted earnings averaged over the last 10 years. It essentially smooths out short-term economic fluctuations.
Right now, the S&P 500’s Shiller P/E ratio’s around 36, double its historical average!
Overvaluation 101
Tesla (NASDAQ: TSLA) stock epitomises this. The electric vehicle (EV) giant’s revenue growth has slowed to single digits and profit margins have declined. In Q2, its sales fell for the second straight quarter.
Yet you wouldn’t know that from Tesla’s share price, which is somehow up 47% in the past six months!
This puts the stock on a forward P/E ratio of 101! In other words, for every $1 of expected future earnings (for 2024), investors are currently paying $101 for the stock.
Mind you, Tesla shares could always go higher after the upcoming robotaxi event on 10 October. But given that EV demand’s sluggish and competition’s mounting, there’s a lot of risk in the current multiple.
Still investing
By contrast, parts of the UK stock market look attractive to me right now. Here are three of them:
- Small-cap stocks
- Some investment trusts trading at double-digit discounts to their underlying value
- FTSE 100 financial shares with ultra-high dividend yields
These are the ponds I’ll be fishing in throughout October.
This post was originally published on Motley Fool
