Question: What could be more exciting than talking about a graph?
Answer: It doesn’t matter, because we’re talking about a graph either way …specifically, this graph.
This article and video are for investors that are excited by the recent S&P 500 US Stock returns over the past few years.
Today we’re sharing some thoughts on a graph and how it relates to the S&P 500 as an investment, and learning from history's patterns.
What you see before is a plain graph right?
Wrong.
This is a fascinating graph, if you look closely. You don’t have to squint, just look for some patterns and concepts.
We have here three different indices: the S&P 500 (which is a big chunk of the US share market), The MSCI World Ex USA, which means 22 other developed countries’ share markets, and the MSCI Emerging Markets Index, which is another 21 developing countries (also known as Emerging Markets or “EMs”).
The graph shows each index and its trailing 10-year returns, separated by five year intervals. So the first bars on the left show 1984, which means it’s taking the returns of those indices for the previous 10 years, starting from January 1975 through to December 1984. The next bars do the same, it’s just five years later.
Now here’s where things get exciting: there are nine periods shown on the graph from 1983 – 2023, but if you look at the S&P 500, which is the dark blue bar, had the highest returns in four of those periods.
Four divided by nine is 44% (4/9=.44). That means that less than half the time the S&P outperformed other diversified share markets. So if you were back in the 1980s and deciding which index to invest in, the S&P 500 would not have been the best option, more than it would have. That's not great.
Emerging Markets
Many investors don’t like the returns from Emerging Markets have offered, and that’s understandable because for the past 10-15 years, they haven’t been very good. But if you look further back, Emerging Markets were phenomenal during and after the Global Financial Crisis of 2008. Part of the reason for that is because the S&P 500 did so poorly, by comparison.
The S&P 500 (as an investment option)
Last time the S&P 500 outperformed these other 2 indices was in the late 1990s and early 2000s, and for those that remember, that’s when the Tech Bubble burst. What came five years later were abysmal returns (because the returns on the graph above show the historical averages with 10-year intervals, not just one-year intervals).
What was once a great investment, became a … not so great investment.
Cycles Change
It’s scary to think that back in 1999 and 2004, the US outperformed other developed and emerging countries’ share markets, by less than what they have done recently. Let me explain, markets go through cycles, which means there’s up periods when everyone is happy, and after the up periods are down periods, where good returns were a distant memory.
In statistics this is called Regression to the Mean.
What it means is that things have a tendency to go back and do what the average over time. In other words, history often repeats itself.
Imagine you and your friends are flipping coins, you flip a coin 10,000 times. There might be some streaks when you flip heads 10 times in a row, but out of the total 10,000 the odds are that all the coin flips will still come out to something like 50/50, or close to it. This is how markets often behave, and because the S&P has done well more recently (since 2009), it might not do as well in the near future.
Likewise, because other developed and emerging markets haven’t done as well recently, they might be more attractive in the near term.
The more unusual a market’s returns are, either up or down, the more likely it is to go swing back the opposite direction, to get back to the average. This is called a correction if markets swing downwards or if it’s big enough, a bear market, when stock markets plummet.
Let's Talk About the S&P 500 (Finally)
Basically the S&P 500 looks so good right now because it’s gotten more expensive. The price has gone up so every investor is paying more money to buy the same companies as before. You can measure how expensive a share market is in numerous ways, but some common ratios are Price to Earnings or Price to Book.
This image shows that the historical Price to Earnings ratio for the S&P 500 has been about 22, which means that if you buy all the companies in the S&P 500, and nothing else changed, it would take 22 years to get your money back from the investment through each companies annual earnings. You can see that, more recently, the number is 40x price to earnings. Put another way, if you invest in the S&P 500 right now (as of late 2024), you are roughly paying twice as much as the historical average, which is not a good sign for the future returns.
Since the year 1970 through to year end 2023, several countries have had better performing share markets than the US and S&P 500, including Denmark (13.53% per year), Hong Kong (12.62% per year), Sweden (12.45% per year)) the Netherlands (11.97% per year) and Switzerland (11.05% per year), while the S&P 500 has done 10.95% per year.
However, if we look over the last 10 years (when the S&P has gone way up), Hong Kong and Sweden haven’t done so well. Sweden’s trailing 10 year returns are 5.23% per year while Hong Kong's are a miserly 2.03% per year. So if you like the idea of investing in countries with strong share markets like Sweden and Hong Kong, remember that the last 50 years isn't the same as the last 10 where they've had poor performance. That can and does happen in just about every market, so it's not unique to Sweden or Hong Kong.
In fact, some 'authorities' will attribute the S&P 500's performance to “US Exceptionalism” ask yourself this question: If the S&P 500 hadn’t performed so well since 2009, would you still want to invest in it?
If the answer is yes, then go right ahead.
But if the answer is no, and you think it’s stupid to invest in a country that’s had poor performance (such as Hong Kong or Sweden), then you are Chasing Returns, and that’s something we’ve mentioned before (see link above). Short version is, chasing returns is not a good investment strategy.
Let's Wrap This Up
While this might sound confusing and leave you wondering, so "what do I do now" – here are some takeaways:
Don’t look at which investment markets have done well and put your money into yesterday’s superstars. You’d be better off doing the opposite by picking previous losers. The best strategy is invest in all of them, by picking a global index that tracks all the countries in the world.
If you are investing more of your money into the S&P 500, just be aware that there have been numerous occasions when the S&P was in a similar position as today (where it was expensive) and it went on to lose value (sometimes for more than 10 years).
Then comes the hardest part of all. Don’t touch it. Let your investments ride. You’ll be tempted to move them every time you look, because the FOMO parts of your brain will ask if you can do better. In theory you could, but in reality, the data are clear that switching investments based on recent performance is a bad idea. This means if you’re committing to an investment strategy, commit to it. Don’t ‘try it out’ for a couple of years and then switch. Continuing to switch investments every so often will hurt your portfolio, leave you with less wealth, less time from researching everything and increase your stress.
Chase your dream, not returns. - Cam Irvine
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Citations and Sources:
DFA Returns Web
Wikipedia: https://en.wikipedia.org/wiki/American_exceptionalism
Investopedia: https://www.investopedia.com/terms/s/sp500.asp
Visual Capitalist: https://www.visualcapitalist.com/complete-breakdown-of-sp-500-companies/#google_vignette
This is great Cam. Just interacted with an investor that was asking why he doesn't just load up on the S&P 500. Keep it up.