Is the S&P500 Failing?

In the most recent 2 months or so across December 2021 and January 2022, we have seen the market hitting the doldrums. December showed signs of volatility and uncertainty as the market tracked by the S&P500 fluctuated between 448 and 473. And the start of January, we witness the fall of the S&P500 on 4th January by 12.5% over 20 days and the NASDAQ taking a harder hit from 15,880 to 13,100 – a good 17.5%.

A quick introduction to S&P500: It's a fund that tracks the growth of the top 500 US companies. For NASDAQ or Dow Jones, they work similarly to the S&P500.

Many would attribute the fall of the S&P500 to the resurgence of COVID and the Fed's interest rate hikes. For a simple background of these two cases, the resurgence of COVID has brought negative sentiments to the overall market in terms of unemployment and rising costs from broken supply chains - leading to a decline in profits for firms. And for rising interest rates, it increases the cost of financing loans which eats into the bottom lines of companies. With such a negative outlook, the US market is taking a beating.

However, will things return to normal?

Historically, the S&P is touted to make 10% per annum over the past 70 years. Its longstanding ability to hold out such a respectable growth is by no means luck or coincidence. However, the saying that historical returns are not indicative of the future may really hold true after all.

If we investigate the historical performance of the US, we see that in the past 10 years, growth is at an amazing 13% per annum. If we believe in mean reversion considering how diversified and normalised a fund is with 500 companies, it will mean that the S&P will be making 7% per annum in the next 10 years. And let us also understand that the US started using Quantitative Easing back in 2009 to curb the Global Financial Crisis.

Quantitative Easing, in short, is effectively “printing money” into the economy through financial institutions to "artificially" stimulate demand through loans to businesses. Some critics argue it would cause inflation and propagators have cited historical data to deny the fact of inflation.

But is it really the case that QE does not drive inflation? It could be very well the fact that the US economy was lengths away from achieving full employment or hitting the maximum potential output possible. Such boosts to the economy would be insufficient to drive significant inflation if there is still space left in the tank for the US to pump in. With the idea of QE, it is akin to borrowing future's growth in exchange for the current's as the Fed must taper the stimulus once the economy hits a certain growth rate. An economy that is driven by stimuli may see itself run out of gas one day.

With the concept of borrowing, we have to return what we borrowed one fine day. And, that day may have arrived for the US with their borrowed future growth. The stellar growth in the past 10 years may indicate a returning back in the coming years. By no means will the US market fall but the sheer confidence we all once have in the market may start to waver or crumble.

Also, if we were to take a look at the US' growth, it may be attributed to the idea of first-mover advantage simply because the US is the world's first superpower in this era. Growth can easily be sustained with economies of scale and network. But as all kingdoms of history come to past, economic superpowers shuffle by a sudden change in developments or through new advancements. In this digital and cyber age, countries in the forefront of these developments will gain the upper hand. Perhaps that is why the US-China Trade War over 5G and data control grew out of proportions.

The US undoubtedly owns the world's best semiconductors or electric vehicles at this point in time from the brilliant minds we very well know of. But we may see a stagnation soon in these extraordinary inventions. On the other hand, greater innovations may come from less-than-expected economies that are catching up in their development status.

The idea of solely investing in the S&P500 and keeping the faith that it will continue making 10% a year may soon disappoint pious investors. Diversification across other geographies may start to sound like a better option.

What are your views in keeping faith in the US ETFs and would you seek to diversify your funds in other economies? Remember: The market does not compensate for risks that can be diversified.

If you're interested to chat on this topic or to exchange ideas, please feel free to drop me a message on Telegram @elijah2212 or through email elijah.thj@gmail.com!