The S&P 500 has been on fire in recent years. Since bottoming out in March 2020 during the pandemic, the index has returned an astonishing 158% (not including dividends).
There have been many reasons for this surge, ranging from artificial intelligence (AI) excitement and falling interest rates to bullishness about the US election result.
The S&P 500 is now into the third year of its current bull market.
However, valuations have become stretched and an increasing number of market watchers are starting to sound the alarm. Given all this, would it be sheer madness for me to invest in the S&P 500 right now?
Bull market cycle
Growth investor Sir John Templeton once said: “Bull markets are born on pessimism, grown on skepticism, mature on optimism, and die on euphoria.”
Stepping back, I think we can broadly see these stages playing out:
- Pessimism: in late 2022, the bull market started after the devastating financial and public health impact of the pandemic.
- Skepticism: in 2023, concerns remained about high inflation, supply chain disruptions, and geopolitical tensions. Yet the S&P 500 continued to rise.
- Optimism: the S&P 500 reached a new record high in early 2024, driven by the ‘Magnificent Seven’ tech stocks and the revolutionary potential of AI.
- Euphoria: Donald Trump is elected, promising pro-growth policies, deregulation and tax cuts. The S&P 500 shoots above 6,000 for the first time in history.
Raging bulls
But are we really in late-stage euphoria? After all, the average bull market lasts longer than two or three years (around five, on average, in fact).
Nobody really knows for certain what happens next. But the index’s price-to-earnings (P/E) ratio is now approaching 30. This isn’t far off the peak reached during the dot-com bubble, a period of excessive speculation in tech stocks that didn’t end well.
The FTSE 100 index isn’t an apples-to-apples comparison to the S&P 500 because it lacks giant tech companies that command higher valuation multiples. Still, a P/E ratio of nearly 30 appears extreme next to the FTSE 100’s 15.
Looking around, I see some crazy individual valuations. Palantir Technologies, for example, is trading on a price-to-sales (P/S) ratio of 54 and a forward P/E multiple of 128.
Meanwhile, Tesla stock has jumped 41% in a month, putting it on a forward P/E ratio of 93. Even Tesla bulls are scratching their heads at the magnitude of this rapid rise!
Utter madness?
The Vanguard S&P 500 UCITS ETF (LSE: VUSA) is the most popular exchange-traded fund (ETF) among investors at Hargreaves Lansdown. Given the index’s stellar performance, that’s hardly surprising.
Around a third of my portfolio is invested in S&P 500 companies, and I’m happy with that allocation.
If this wasn’t the case though, I don’t think it’d be silly for me to buy a small slice of this S&P 500 tracker right now. But only assuming I was committed to investing for years rather than months.
After all, a sharp pullback could be just around the corner given the historically high valuation.
Longer term, however, I think the tech stocks dominating the index have tonnes of potential. We’re living through a powerful digital/AI revolution, and the companies at the very centre of it are all in the S&P 500.
This post was originally published on Motley Fool
