Market Update

Last month was my 20th anniversary in this industry and I’ve come to realize that at some point in every speculative investment boom I start to hear the question, “Why do we own anything other than (fill in the blank)?”  As in;

• Why do we own anything other than AOL/Netscape/Cisco Systems (or tech stocks in general) in the late 90’s, or
• Why do we own anything other than pre-development condos in Scottsdale (or real estate in general) in late 2007, or
• Why do we own anything other than bitcoin (or cryptocurrency in general) periodically for the last 10 years

Today’s version is “Why do we own anything other than the S&P 500?”  The S&P 500 is just the largest 500 companies in the United States and that list of companies has outperformed just about every other part of the global stock market over the last year and a half or so.

The answer, of course, is that we own more than just the S&P 500 because we want to be as diversified as we can.  It’s the old principle of not holding all your eggs in one basket.  We definitely want to invest in the S&P 500 but there are roughly 55,000 publicly traded companies in the world today which means that the S&P 500 is less than 1% of the total.  We don’t want to limit your portfolio to less than 1% of the global opportunity set.

Beyond that, the S&P 500 is “market cap weighted” which just means that the more valuable a company becomes, the larger a part of the S&P 500 it makes up.  Today, the largest 10 companies make up more than 33% of the S&P 500.  That’s higher than it’s been in at least the last 30 years (including the late-90s tech bubble).

Since 1996 the S&P 500 has had an average price-to-earnings ratio (P/E) of 16.5.  In other words, for every $16.50 you invested into the S&P 500, your share of those 500 companies would generate $1 of profits per year.  That means it would take 16.5 years of profits to pay back your investment if those companies didn’t grow and become more profitable over time.  Today, the largest 10 companies in the S&P 500 have a P/E ratio of 28.4 – much higher than the historical average.  That doesn’t necessarily mean they are going to crash anytime soon.  P/E ratios are a notoriously bad tool for trying to time markets.  But it does mean those 10 stocks are a far cry from being any kind of screaming deal.

In the last nearly 100 years, there have been two ways to permanently destroy wealth in the stock market – investing in an undiversified way and selling when the market is down.  Over the last two years we’ve all battled the temptation to sell while the market was down.  Going forward, it seems we may all be faced more and more with the temptation to invest in an undiversified way by chasing the hottest parts of the market, whether that’s the full S&P 500, or just large cap growth stocks, just the “Magnificent 7” stocks, or why not go all the way and even invest in just Nvidia itself!  Needless to say, we think that would be a mistake.

Hang in there and we will keep making sure that your portfolios remain thoroughly diversified!