23 June 2023 Asset Allocation | Equities

Is the S&P 500 A Good Investment? How To Invest in SPX

We are underweight equities in our Asset Allocation model. That means we expect falling prices, and we think now may not be a good time to invest heavily in the S&P 500.
However, our momentum model is giving a buy signal for all three lookback windows. That is a bullish signal overall and suggests rising prices.
The macro backdrop remains bearish: lofty valuations amid the big tech rally could become a headwind as interest rates continue to bite.

Is Now a Good Time to Buy the S&P 500?

We do not think now is a good time to invest heavily in the S&P 500 if you have a short- to medium-term horizon. We underweight equities in our broader Asset Allocation framework because inflation is still high, and we do not think the Federal Reserve has finished hiking despite market expectations of cuts in 2023.

Further hikes will drag on the economy and may induce a recession, which limits the upside for equities and suggests risks tilted to the downside. Although the hype around artificial intelligence stocks is causing the broader S&P 500 to rise, the recent equity rally is narrow. That means it is limited to a few high-performing names, which typically bodes poorly for the durability of the rally.

However, over a longer-term horizon, such as five years or more, the S&P 500 represents a good investment opportunity outside of recessionary periods.

Recent Events Impacting the S&P 500

The biggest news is the recent rally in stocks related to artificial intelligence. Ever since the release of ChatGPT earlier this year, companies that have been able to tout AI developments or intentions in their earnings have experienced considerable gains.

For example, the multinational technology company Nvidia is up a staggering 195% so far this year. Other techy companies such as Oracle and Adobe have also gained recently.

Strategists weighing in on the equity rally (and tech in particular) fall into two camps – those calling for a recession and a return to bear market conditions; and those who say recession risks have passed and see further upside. We have not seen anyone calling for an imminent bull run to last year’s highs.

Will the S&P 500 Rise or Fall? (Short-Term View)

We think equities can continue to drift higher. This move would come partly from the AI rally and partly from the Federal Reserve having paused interest rate hikes at its latest meeting. Currently, the Fed is indicating that its primary objective is maintaining full employment rather than corralling inflation, bolstering risk sentiment.

However, a return to hiking is likely, and a significant rally appears unlikely given a flat earnings outlook in coming quarters.

Here is our latest trading view.

Momentum Model Signals

Momentum models are producing bullish signals for all three lookback windows for the S&P 500 (Table 1). Our most successful model, the 1-month lookback, has returned +5.6% over the past three months. On average, the models have returned 3.9% over the period. The S&P 500 would need to fall below 4,222 for the 1-month model to turn bullish.

Should I Buy the S&P 500 Now? Momentum Models Suggest Yes

Is the S&P 500 a Good Investment Long Term?

Over the last two decades, the S&P 500 has outperformed European equity indices like the FTSE 100 and the Euro Stoxx 50. Legendary investor Warren Buffet once said that all it takes to make money as an investor is to ‘consistently buy an S&P 500 low-cost index fund.’

And academic research tends to agree that the S&P 500 is a good investment in the long term, despite occasional drawdowns. According to a recently published paper in the highly rated Journal of Banking and Finance, ‘any investor would be better off investing in stocks rather than in risky bonds, as long as the portfolio included a riskless asset – a Treasury Inflation-Protected Security (TIPS)’.

S&P 500 Historical Chart

Chart 2 shows the performance of the S&P 500 over the past 23 years. As is evident, the index has shown strong growth aside from periods of turmoil such as the 2008 Global Financial Crisis and the 2020 Covid-19 pandemic. Also, earnings flatlined during 2014-2015 due to a slowdown in technology earnings and a shakeout in the oil and gas industry when oil prices fell from near $100 to below $60.

The Bottom Line: Should I Buy the S&P 500 Today?

In short, we do not think now is a good time to invest heavily in the S&P 500 if you have a short to medium-term horizon. We are bearish on equities in our broader Asset Allocation framework because we think the Fed will continue raising rates until the economy and labour market slow significantly and because of the banking crisis.

We expect equities to trade in a range for now, with a bias toward the downside given the Fed is likely to return to raising rates and fighting inflation. However, over a longer-term horizon, such as five years or more, the S&P 500 represents a good investment opportunity outside recessionary periods.

A Beginner’s Guide to Investing in Stocks

How to Make Money Investing in the S&P 500

A simple strategy for investing in the S&P 500 is to buy a set dollar amount each week or month and hold it for the long term. This is known as dollar-cost averaging.

Dollar-cost averaging is a strategy where you divide the total amount you want to invest across periodic purchases of the target asset. It simply means that you would invest the same number of dollars each month or quarter, regardless of market trends.

The idea is that when prices are high, you can afford less of the asset. But when prices are low, you can afford more. When the market recovers, you benefit from having bought more shares at the lower price. Please note that using this strategy will not always result in a profit or necessarily protect you from falling prices.

Once you start to learn more about investing, you can adjust your portfolio according to prevailing trends. For example, during a market downturn, you may decide to underweight stocks compared with other asset classes like cash. And during periods of high growth, you may decide to overweight equities. You can find all our in-depth views on trading equities here.

How to Invest in the S&P 500

A great way to gain exposure to the whole of the S&P 500 without having to invest in individual stocks is through an exchange-traded fund (ETF). It is best to focus on the large, liquid and cheap funds. We use SPDR S&P 500 Trust ETF (SPY) in our Equity Trades portfolio.

Other options include the iShares Core S&P 500 ETF (IVV) and the Vanguard S&P 500 ETF (VOO). You can find more information on ETFs and funds with exposure to the S&P 500 at ETF.com.

Should I Buy the Dip?

Some say the best time to buy the S&P 500 is during price dips. This seems alluring at first – catching a cheap price and benefitting from the rebound. However, timing dips is notoriously tricky and fraught with risk. What happens if it was not a dip but the start of a long-term decline in prices?

We suggest paying attention to the long-term macro backdrop when asking yourself, should I buy the S&P 500 right now? Your exposure to equities needs to be appropriately sized so that you can survive drawdowns. Drawdowns provide good entry levels for exposure, but we would not go max long in an environment of rising central bank rates and falling global growth momentum.

Stocks vs Bonds: Which Is Better?

For investors deciding on an asset allocation framework, recent research helps confirm one thing – holding a larger share in equity indices than in bonds is more fruitful over time, even when adjusting for risk. By doing so, you can trump the alternative of a bonds-heavy portfolio in periods of both market tranquillity and chaos. The key is to ensure you include a risk-free asset. Otherwise, there is no guarantee holding more stocks than bonds yields higher returns in the long run.

The exception to this rule is around recessions, when equities (stocks) tend to underperform bonds. This is especially true from six months before a recession onwards (Chart 3). They have fallen on average by 4% versus cash in the six months leading up to the seven US recessions we have had since 1970 and by 6% in the three months leading to them. The falls are even larger after a recession, with stocks dropping an average of 11% in the six months after.

Meanwhile, US bonds tend to outperform both in the immediate run-up to recessions and after. The clearest performance is in the three months leading up to a recession when bonds outperform cash by 3%. They also rally after the start of a recession.

Top 6 Tips You Need to Know Before Investing in the S&P 500

Clear Your Outstanding Debts

We do not mean your mortgage or other long-term loans with low interest rates – like student loans. We are talking about the kind of short-term debt that can eat into an investor’s profits, like credit cards. It is no good earning 10% a year on your investments if you have a huge bill on a card that charges 24% APR.

Likewise, it is rarely a good idea to borrow money to invest unless you are a professional. Leveraged exposure can mean you lose more than you invest in the first place. Or as Nancy Davis puts it, ‘Do not spend your bonus until you’re paid your bonus!’

Give Your Money a Goal

Before you dive head-first into investing, figure out how much money you want to put away and what kind of goals are important to you. You might have a specific amount in mind – like $100,000 – or you might want to save up for a particular purchase. Maybe your goal will be savings for when you retire, or maybe it will be enough for a vacation or new car.

Determining when you will need or want to use that money is also important because it determines how much risk you will need to take. Longer-term investments are typically less aggressive but lower risk, and vice versa. Whatever your goal, ensure it aligns with your risk tolerance.

Do Your Research

You should only invest in assets or markets you understand. Do what Scott Lynn does and ask yourself, ‘How much do I really know about what I’m investing in?’ If you cannot understand the product, it is highly likely you will expose yourself to fees or losses you do not anticipate.

For example, before adding a stock to your portfolio, learn about these numbers:

Price to earnings (P/E) ratio.
Price to earnings growth (PEG) ratio (calculated by dividing P/E by annual earnings per share growth).
Price to book ratio (P/B) ratio (calculated by dividing the stock price by book value).
Return on equity (ROE) and return on assets (ROA).

Understand Your Risk Tolerance

Work out what you can afford to lose and match your exposure accordingly. As Ari Paul says, ‘In theory, risk is only sizing. So, if you think Bitcoin is too risky…you could size it at 0.1% of your portfolio or 0.001%. Too risky is never a reason not to own an asset. If something is positive expected value, risk adjusted, and relatively low correlation, you should own it.’

However, do not be afraid to take some risks. Ultimately, with risk comes reward. As Rick Seeger says, ‘Take risks. Know what you can afford to lose and know where you can go with it, sure. But some of the best things from investing come from some of the biggest risks.’

Be Wary of Your Emotions

Frustration and fear are the two killers of profit. Check your emotions as you decide – is anything affecting your desire to buy or sell right now? Some researchers argue investing is 80% psychology, so learning to break down and analyse your emotions as a dataset can give you greater clarity and make you more rational. We have a whole article on how to do that here. If you are unsure, step away. Anas Alhajji said the best investment advice he ever got was ‘kind of a funny one – before you click, leave the room and come back after five minutes.’

Diversify Your Risk

Never put all your eggs in one basket. Your portfolio should hold a variety of assets that respond differently to particular scenarios. So, look for asset classes or geographical regions that have a low or negative correlation so that if one falls, the other rises or remains unaffected. A good way to diversify early on is to invest in index funds, giving you exposure to all the companies in a particular index, such as the S&P 500 or FTSE 100.

How Does the S&P 500 Compare With Other Assets?

The Nasdaq 100 vs the S&P 500: the Nasdaq 100 outperformed the S&P 500 over the past five years (80% vs 52%)
Dow Jones vs the S&P 500: the S&P 500 outperformed the Down Jones Industrial Average over the last five years (52% vs 43%).
Gold vs the S&P 500: the S&P 500 outperformed gold (GC1:COM) over the past five years (52% vs 37%).

FAQs

What does S&P stand for?

S&P stands for Standard and Poor’s, which is company that provides indexes like the S&P 500. S&P also acts as a data source of independent credit ratings, which you can find on the S&P Global Ratings website.

What companies are in the S&P 500?

The 500 largest publicly traded companies in the United States are in the S&P 500. The index contains many well-known companies, such as Apple, Microsoft, Amazon, Alphabet and Berkshire Hathaway Inc. Here you can find a list of all the companies in the S&P 500 arranged by weight.

What is the S&P 500 dividend yield?

The dividend yield for the S&P 500 was 1.69% in November 2022. The dividend varies each month, however, between 2010 and 2020 it remained in a range mostly between 1.80% and 2.20%. Here is the data for the S&P 500 dividend yield by month.