Why You Should Stay Clear From The S&P 500
Introduction
Remember in 2009 when fund managers/advisors were telling their clients that emerging market funds were the best places to leave your money? Does anyone else remember the great returns that emerging economies were generating investors from 1999-2009? If you do, you’d probably remember an advisor telling you or your client to take a position within an emerging market fund, what was the rationale? Past returns. However, fast forward 11 years later and the S&P 500 dominated the international indices, particularly emerging markets. It seems we are at a similar scenario today with the S&P 500 and the rise in popularity of “passive” investing. I completely understand the appeal, financial advisors aren’t necessarily ethical or smart, and quite frankly financial institutions over charge for their investment products. Why not just buy an ETF, pay a fraction of the price, do no work, and watch your money compound at 15% annually. It’s a money COMPOUNDING CHEAT CODE! Unfortunately all good things must come to an end as the S&P 500’s dominant run could be in jeopardy and the promise for above average returns may not necessarily be fulfilled.
Divergence
The S&P 500 has seen great divergence from the United State’s GDP over the past 10 years, indicating that valuations have been pushed much higher from fundamentals.
Source: CurrentMarketValuation
Economist point fingers at low interest rates, strong economic growth, deficit spending and the new found desire for passive investing. I am of the opinion all of the above had some sort of factor with the S&P’s 11 year tear. Passive investing has made investors pay $1.10 for a $1.00 and they don’t seem to care. However, it’s not as much the high multiples in which concerns me with the S&P 500 as the possible catalyst that may end the parade.
Debt Deflation
The United States has a highly leveraged economy with a 125% total debt to GDP
Source: MacroTrends
If asset prices were to decline, especially in real estate, we could see a secular period of debt deflation. Debt deflation can occur when asset prices fall, causing citizens needing to save money to pay off debts as supposed to simply selling collateral they may have pledged to cover that debt. Instead of money being spent into the economy, it’s used to pay off debts that you’re written down assets could not pay off for you. This explains why extremely long periods of asset inflation is followed by secular deflationary periods much like Japan during the 1990’s and the U.S in 1929. In addition, this is also why I don’t think the Fed will taper its bond purchases despite all of the hawkish talk.
Political Risk
The United States undoubtably has a few major political issues but for the sake of this article, we are just going to mention the political divide between the Republicans and the Democrats. Both parties seem incapable of agreeing on anything, even if it involves a debt ceiling in which at its worst, could directly cause a ripple effect throughout the entire global economy. The country’s political divide is a major risk going forward , if the U.S cannot unite or at least govern in a more cohesive manner then people may begin to lose faith in their system. Democrats want to ruin people’s lives on twitter with cancel culture, while republicans believe in every conspiracy about the establishment possible. It is becoming increasingly hard to watch an American news network and say confidently that I want to invest in American markets.
Conclusion
I cannot predict stock market returns and I do not try too. That being said, I thought it would be important for me to highlight a couple of the underlying risks with investing in the S&P 500 going forward. Don’t make the mistake a lot of emerging market investors did and bank on past returns as rationale for your investment decision. I encourage my subscribers to diversify out of the S&P 500 and into small cap equities, international funds and even Gold.