The S&P 500 index continues to defy gravity even as COVID-19 cases rise in the US.
Investors whom I’ve been talking to are understandably getting nervous. Will the S&P 500 eventually come crashing down to reflect the recession the world is living in?
Distinguishing the S&P 500 index from the economy
The first thing I want to point out is that the S&P 500 is not an accurate representation of the US economy.
The S&P 500 represents a basket of 500 of the biggest companies listed in the US. Although it may be tempting to assume that this basket of stocks should rise and fall in tandem with the whole economy, reality looks different.
There are 32 million businesses in the US, so the S&P 500 is just a fraction of this. In addition, the S&P 500 is a market-cap-weighted index that is heavily weighted toward just a few big firms such as Apple, Amazon, Alphabet, and Facebook. These mega-cap tech companies have arguably thrived during the COVID-19-induced lockdown.
Amazon, for example, had a big jump in sales due to the need for social distancing. Facebook double-downed on investing its spare cash. With so much cash on their balance sheets, these tech giants can find bargains at a time when other businesses are struggling for cash.
If these mega-caps rise in value, it can positively skew the S&P 500.
But should we invest at all-time highs?
Another concern is whether we should invest at all-time high prices? The reality is that the S&P 500 reaching new all-time high prices is actually not that uncommon.
Engaging-data.com has some interesting data related to this topic. Between 1950 to 2019, there were a total of more than 17,000 trading days. Of which, the S&P 500 reached an all-time high on 1,300 days. Interestingly, if you invested on days after the S&P 500 reached all-time highs, you’d be doing just as well as if you invested on any other day.
The chart below compares your returns if you bought at all-time high (ATH) prices vs if you bought at any other time.
If you bought the S&P 500 the day after it hit a new high, your mean return over five years was 53.7%. If you bought on any other time, your mean return was 50.0%. I checked the 10-year return data, and the numbers point to the same conclusion. The mean return after 10 years, if you bought at a high, was 103.2% compared to 114.7% if you bought on all trading days.
The data shows that investing during new market highs, contrary to popular belief, gives you very similar returns to if you invested at any other time.
If this is a market peak?
But what if this market high is a peak and stocks do come crashing down after this? In this case, your returns will most likely not be as good as if you invested before or after the crash. However, that doesn’t mean you will have poor returns per se.
Ben Carlson, a respected financial blogger and wealth manager wrote an insightful piece in 2014 on investing just before a market crash.
In his article, Carlson wrote about a fictional investor who somehow managed to time his investments at all the worst times over a 40-year period. The investor invested in the S&P 500 just before the crash of 1973, before Black Monday of 1987, at the peak of the tech bubble in 1999, and at the peak before the start of the Great Financial Crisis of 2008.
Though this frictional investor was a terrible market timer, he was a long-term investor and never sold any of his positions. Despite his terrible luck in market timing, he ended up making a 490% return on his investment over his 40-year investing period.
This goes to show that even if you invest just before a crash, stocks tend to rebound and will eventually reach new peaks.
There are a few takeaways here:
- It may be scary to invest in the stock market when it is at an all-time high. It is especially scary when the economy is in a recession, as we are seeing today. However, the S&P 500 is not the economy.
- Not all companies have businesses that live or die by the broad economy. Some thrive during times of crisis and investing in these “anti-fragile” companies can pay dividends down the road.
- Whether the S&P 500 is at an all-time high or not shouldn’t make a difference to a long-term investor. The stock market tends to keep making new highs.
- Even if stocks were to fall dramatically tomorrow, if the past is anything to go by, investing in a broad index like the S&P 500 over the long-term will still provide a very decent return over a sufficiently long investing period.
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Note: An earlier version of this article was published at The Good Investors, a personal blog run by our friends.
Disclosure: Jeremy Chia does not own shares in any of the companies mentioned.