The S&P 500 has been on a phenomenal run over the last two years. Sure, the performance pales in comparison to some blockbuster tech stocks like Nvidia (NASDAQ:NVDA). However, compared to the historical average return of 10% per year, S&P 500 index investors have been reaping enormous gains lately.
When factoring in dividends, the US’s flagship index has generated a 56% return since March 2023. That’s a 24.9% compounded annual return, beating even Warren Buffett’s already impressive average of 19.9% per year.
That means if an investor had put £10,000 to work in an index fund, they’d be sitting on a portfolio worth £15,600 today. The same investment in the UK’s FTSE 100 would only be valued at around £12,500 over the same period.
Digging into the details
Much like the FTSE 100, the S&P 500 is a market-cap-weighted index. That means the larger a company is, the more influence it will have over the performance of its parent index. And in recent years, that’s started to create some portfolio concentration issues even among index investors.
Just five companies in the index, Apple, Nvidia, Microsoft, Amazon, and Meta Platforms, account for 25% of it by weight. So, when these companies do as well as they have done, index investors reap the benefit. Unfortunately, the opposite is also true. It’s why the S&P has taken a bit of a hit in recent weeks. Shares of Nvidia dropped by almost 20%, Meta Platforms fell by 11%, and Amazon is down 15%.
What’s going on?
With so many factors influencing the stock market in the short term, it’s impossible to pinpoint the exact cause of recent turbulence. However, the general consensus among investors appears tied to the impact of new trade tariffs being imposed by the US.
In the case of Nvidia, most of its chips are made in Taiwan. However, the group also has some manufacturing activities in Mexico. These are expected to be affected by the 25% tariffs on Mexican imports.
It doesn’t help that management was unable to clarify their expectations in the latest earnings report. It said” “Tariffs at this point, it’s an unknown until we understand further what the US government’s plan is.” And when a stock is trading at a premium valuation, such uncertainty unsurprisingly triggers volatility.
Time to buy?
Volatility often creates opportunities for investors who are comfortable taking on risk. The threat of tariffs cannot be ignored. However, in the long term, well-run companies will eventually adapt to shifting macroeconomic and geopolitical landscapes.
Having said that, when looking at Nvidia, the shares continue to trade at a lofty valuation with a price-to-earnings (P/E) ratio just shy of 40. In other words, even with all the recent volatility, the tech stock is still expensive. The same is true for the S&P 500 as a whole.
The index’s average P/E ratio sits at 29.7 versus its historical average of 18, suggesting that most of its largest constituents have a lot of catching up to do to justify their current valuations.
Therefore, all things considered, I’m preparing for volatility in the short term, looking to snap up bargains when they appear. After all, the long-term potential of these leading enterprises still looks promising in my eyes.
This post was originally published on Motley Fool
