The stock market movements can be tricky, especially during times of crisis. Today we are going to explore the S&P 500 index. We could have used another indexes like Russell, Nasdaq or the Vanguard 500 Fund, but the S&P 500 is considered the most important benchmark for investments in the world and it represents a “market capitalization-weighted index of 500 leading publicly traded companies in the U.S.”, as presented by Investopedia here. To beat the S&P 500 index is the only way to generate “Alpha” returns. It may be easy to beat it for some years, but it has been hard to generate Alpha returns after 10, 20 or 30 years in a row.
It looks like the bear market has been officially decreed for the global economy. The S&P 500 is 20% down since the 3rd of January ’22 driven mainly by the fear that the Federal Reserve won’t be successful in the task of controlling inflation. The combination of high-interest rates and continuous surges in price indexes act like a fissure on a nuclear reactor: impossible to contain.
Stock Market update
COVID has found the world in 2020. Figure 1 shows about 35% drop in the S&P500. Be aware: the lowest level was between 2,100 and 2,300 points. Let’s take a look at what happened with the S&P 500 index from November 2019 to July 2020. Figure 1 shows the S&P Daily closing prices during this period
If we change the period for March to June of 2020, then Figure 2 shows a different movement:
If we don’t zoom out enough, it will look like the bear market is here to stay, right? Wrong. Take a look at the lowest level (about 3,900 points). This represents an almost 80% increase over March 2020. Let’s go further and zoom out both periods together.
Despite what the 1st and 2nd charts alone led us to believe, the 3rd seems bullish to us. Let’s do a final exercise and zoom out to 1928. Let’s now use the S&P 500 P/E (Price to Earnings) ratio which represents the price divided by the earnings per stock. The shadow areas represent economic recessions.
The PE ratio is intuitive. It goes up if the price goes up higher than the earnings per stock. On the contrary, the PE ratio goes down if the earnings per stock go up, but the price doesn’t follow. The ATH for this period was in May 2009, when PE ratio reached $122. This means that the investors were willing to pay $122 per unit of earnings.
In the last 24 months, the PE ratio got from a maximum of $36,86 (November, 2020) to about $20,83 today. Comparing a few examples, this is almost the same level that we had in February 1931, January 1946, May 1987 and November 2007.
The conclusion is quite simple. Even though the technology has advanced, companies are stronger, and earnings are much higher, people remain the same: zooming stock charts in and making poor decisions. You’ll not see a bear market if you zoom the stock charts out, but a huge golden opportunity.