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The S&P 500 is Expensive, But is it Worth It?

shares stock market

  • Traditional metrics for valuations and price to earnings continue to put the S&P 500 at a premium compared to other indices in Europe and Japan
  • S&P 500 may still justify its valuation given that it is highly adaptive and able to co-opt fresh companies in burgeoning industries, providing upside to investors

Conventional wisdom suggests that it’s acceptable to pay a little bit more for quality, whether that’s clothes or cars, homes or horses, but what about the S&P 500?

Shares in the benchmark S&P 500 index have long traded at a premium to global peers, but the trend has been reinforced by the steady transformation to more closely resemble the Nasdaq Composite, with more tech-oriented and highly profitable companies growing to quickly shoulder the bulk of the index’s value.

The S&P 500’s slant towards tech is in sharp contrast to indices in Europe and Japan, which are more heavily influenced by companies from slower-growing industries such as financials, materials and industrials.

But that tech-heavy leaning of the S&P 500 has also sparked frequent warnings that the future returns will eventually prove disappointing.

And although valuations are a good starting point for divining the scale of future returns, they are really just one element in a broader financial picture, because investors also need to consider the production line of new companies joining the S&P 500.

For instance, just one decade ago, energy stocks accounted for 12% of the S&P 500, which in light of the sector’s subsequent poor performance, ought to have dragged down the index along with it, but instead, the rise of tech firms transformed the S&P 500, supercharging much of its performance.

Investors looking at the S&P 500 shouldn’t approach it on the assumption that it remains static, but rather that it is a living, breathing organism, absorbing and assimilating the latest growth sectors and delivering to investors what the U.S. economy looks to represent at any given snapshot in time.

A bet on the S&P 500 then is really a bet on America.

And is that worth paying a premium for? For many investors, the answer is still an unequivocal “yes.”

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© Copyright of Novum Global Consultancy Pte Ltd {2020, 2021}. All rights reserved.

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