ETFs
Is the Vanguard S&P 500 ETF still a buy? Here’s what the story says and why you should ignore it.
U.S. large-cap stocks continued to post new 52-week highs in 2024. Despite tight fundamentals, investors may want to stay the course.
The American stock market is on fire. THE S&P500 The index, a benchmark for U.S. stocks, has hit new all-time highs this year and trades a staggering 70% above its historical average when measured by the cyclically adjusted P/E ratio over 10 years, known to many as the Shiller P./E Report.
The question on many investors’ minds is whether now is the time to exit from stock investments, especially those that track this benchmark index like the Vanguard S&P 500 ETF (VOO 0.68%).
To answer this question, we must consider the lessons of the past in the context of the unprecedented era that humanity is entering.
What the past can teach us
Historically, buying stocks in the S&P 500 at all-time highs has been wise. Valuation metrics such as the Shiller P/E ratio lack predictive power for stock or index movements in the short term, typically less than a year.
Instead, market momentum is a more reliable indicator over periods less than a decade, with indexes often gaining incremental gain. 12.7% within 12 months of reaching all-time highs.
This phenomenon is fueled by “recency bias,” whereby investors favor recent market performance over long-term fundamentals, which could lead to overvaluation and subsequent market corrections.
So, despite the S&P 500’s current Shiller price-to-earnings ratio of 34.7, significantly higher than the modern-era average of 20.3, it may not be time to move into risk-free assets like bonds or high-yield money market accounts.
Image source: Getty Images.
After all, market dynamics indicate that further gains are on the horizon. That said, S&P 500 bull markets that result in strained valuation metrics typically lead to multi-year bear markets, characterized by the outperformance of risk-free assets relative to stocks.
History, in turn, suggests that the favorable decision is to continue buying core funds like the Vanguard S&P 500 ETF for another two to three quarters while keeping an eye on the underperforming bond market. Further analysis suggests that stocks could be on the verge of breaking away from this trendline, setting the stage for a prolonged rise in the S&P 500 over the next few years.
What the future may hold
We are witnessing a unique phase in financial history. Technological innovations could make past trends irrelevant and shake up conventional wisdom.
The advent of artificial intelligence (AI), autonomous vehicles and the automation of labor-intensive jobs will revolutionize society over the next five years.
For example, the current displacement of jobs by AI, with Goldman Sachs predicting that 300 million full-time jobs could be replaced highlights the scale of this transformation.
This rapid technological evolution requires a reevaluation of traditional concepts such as the value of a four-year college degree and the future of industries like auto insurance and entry-level employment.
All of these pressing issues will have a significant impact on stock market valuations in the years to come. So, as we navigate this AI era, our approach to valuing investments may also need to adapt.
The stock market appears to be anticipating these changes, with chipmakers like Nvidia (NVDA 2.57%) at the forefront of this change. After all, Nvidia’s action, which is at the heart of the AI revolution, has done so over the past five years:
In short, these technological advances are already reshaping the American stock market.
What this means for investors
Investing in the AI era presents both enormous challenges and life-changing opportunities.
While historical trends can provide valuable insights, the unique circumstances of today’s market and the transformative impact of emerging technologies require a fresh perspective on investment strategies.
The current performance of the US stock market could be the harbinger of a new era in investing. Traditional valuation measures may need to be supplemented with a deeper understanding of technological advancements and societal changes.
This emerging theme, in turn, should propel U.S. large-cap stocks higher for an extended period. The Vanguard S&P 500 ETF is therefore considered a blue-chip buy, despite its premium valuation and tendency to revert to the mean when its valuation breaks historical precedent.