In the past decade, the S&P 500 index (SNPINDEX: ^GSPC) registered a total return of 303% (as of April 17). On an annualized basis, the 15% gain is significantly higher than the market’s long-run historical average. With a stellar performance like this, it might encourage anyone to seriously consider putting money to work.
But first, it’s important to gain a better understanding about this market before buying anything. Here are five things every investor should know.
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After the benchmark’s strong gains in the past 10 years, there has been a lot of discussion about the market’s current valuation. The S&P 500 index trades at a CAPE ratio of 40.4 today. In the past 155 years, it has been higher only during the dot-com bubble period. Data is clear that higher starting valuations result in subpar returns going forward.
The counterargument is that currency debasement, resulting from substantial fiscal and monetary stimulus since the Great Recession, has been a key contributor to rising asset prices. M2 money supply in the U.S. has climbed 167% over the trailing 16-year period. It’s ridiculous to think this has not had a profound impact on stock market performance.
Today’s stock market is dominated by technology companies, namely the “Magnificent Seven.” According to research from The Motley Fool, these stocks represent about one-third of the S&P 500’s market value. There’s no reason to believe these kinds of businesses won’t continue to attract the most attention among investors and drive returns in the future.
Even at their massive scale, these companies generally still possess impressive growth potential. They are highly profitable, benefit from powerful network effects, and have global user bases.
This next point is somewhat related to the first factor about valuation. It’s becoming increasingly difficult to assess whether a stock is cheap or expensive. That’s because with information flowing so freely thanks to the advent of the internet, coupled with the fact that retail investors represent a bigger share of the stock market, it’s obvious that narratives matter more than ever.
Tesla provides the perfect example. Its automotive operations have exhibited slow growth and declining margins in the past couple of years. However, the electric vehicle (EV) stock trades at a nosebleed price-to-earnings ratio of 372 simply because Elon Musk is an excellent storyteller.
