Understanding the S&P 500's Milestone: A Guide for Beginner Investors
In an event that captured the attention of investors worldwide, the S&P 500, a key benchmark for U.S. equity markets, momentarily surpassed the 5000-point threshold yesterday before closing slightly below at 4998. This landmark moment is more than just a number—it signifies a variety of underlying economic and market sentiments. Reflecting both the resilience and the evolving dynamics of the U.S. stock market. Driven by a handful of companies that have significantly outperformed, following the latest announcement of Q3 Financials.
There were some notable and surprising numbers produced by several global names we all know and love. For example, Uber (Ticker: UBER) reported its first-ever annual operating profit of $1.1 billion, compared with a $1.8 billion loss in 2022 following the harsh recovery from COVID-19 and the slowdown in mobility. Does this act as an inflection point for the company, or is it driven by broader market movements?
Another familiar name is Disney (Ticker: DIS), whose performance in the stock market over the last year had been lacklustre, to say the least. The stock had been on a downfall since its highs of $156 in February 2022 before a recent recovery in October 2023. However, it was the latest financials, which surprised analyst expectations following strong Disney+ subscriber growth and a deal with Epic Games, the producer of the popular video game among the younger generation, Fortnite. So, what does this mean for some of the key competitors, Netflix, and Microsoft (who recently acquired Activision Blizzard, producer of Call of Duty)? It is safe to say that Netflix is still winning the streaming wars. Disney recently allowed Netflix the right to license some of their own content, showing more of a collaborative approach, and with the rise of gaming and its appeal to generations under 40, Microsoft may now have found itself even stronger competition.
We can't mention Microsoft without discussing Artificial Intelligence (AI). Pushed into the limelight by the release of OpenAI's powerful ChatGPT, several companies have greatly benefited from the rise of AI in the last year, which is certainly a significant contributor to the extraordinary gains we have seen in the stock market. Although the following do not sit in the S&P 500, chip maker ARM Holdings PLC and data company Palantir have been examples of the impact this technology is having on valuations, with both companies achieving daily gains of over 50% and 25% respectively, following the latest financials.
Consider this to be general commentary on a small handful of companies. Only half of the companies in the index posted gains this year, and even fewer have outperformed the index itself. You may recall "the magnificent seven." The Russell 2000 Index, representing smaller U.S. companies, tells a more sobering story, languishing around 20% below its 2021 peak. This is greatly attributed to their greater sensitivity to interest rates, compounded by their higher leverage (debt) and weaker profit margins. Equally, as many people have been forced to pay extra money on their mortgage, companies with high levels of debt have incurred this added burden.
What does this headline mean for someone with basic investment knowledge?
Lets break it down.
What is the S&P 500?
First, it's crucial to understand what the S&P 500 is. The Standard & Poor's 500, or S&P 500, is an index comprising 500 of the largest companies listed on stock exchanges in the United States. It's widely regarded as one of the best single gauges of large-cap U.S. equities. Think of it as a thermometer measuring the health and temperature of the overall stock market.
Why is the 5000 Point Level Significant?
Crossing the 5000-point mark is symbolic and significant for several reasons:
Psychological Impact: Round numbers, like 5000, act as psychological benchmarks for investors. They are easy to remember and serve as markers of the market's performance over time.
Indicator of Economic Health: The S&P 500's performance is often seen as a reflection of the economic and corporate health of the United States. Reaching 5000 points suggests optimism about future earnings and economic growth.
Investor Sentiment: This milestone indicates strong investor confidence in the market. It suggests that investors are willing to invest in stocks, anticipating future growth.
What Does This Mean for the Average Person?
For individuals with basic investment knowledge, the rise of the S&P 500 to 5000 points can be interpreted in several ways:
Long-term Growth: It highlights the potential for long-term growth in the stock market. If you're investing for retirement or other future goals, this milestone is a positive sign that the market can provide substantial returns over time.
Market Volatility: The fact that the index briefly surpassed 5000 before closing just below it also serves as a reminder of market volatility. Prices in the stock market can fluctuate widely in short periods, influenced by numerous factors, including economic data, corporate earnings, and global events.
Diversification Importance: The S&P 500's movement is a good reminder of the importance of diversification in an investment portfolio. Investing across a broad range of assets can help manage risk, especially during market fluctuations.
Moving Forward
For beginner investors, the excitement around the S&P 500 reaching 5000 points serves as an educational moment to understand market dynamics and the importance of investing with a long-term perspective. It's also a reminder that while milestones like these are noteworthy, they should not drastically change your investment strategy without considering your financial goals and risk tolerance.
Here are a few tips moving forward:
Stay Informed: Keep an eye on market trends and understand how they align with your investment goals.
Diversify: Ensure your investments are spread across different asset classes to mitigate risk.
Think Long-Term: Short-term market movements can be thrilling or terrifying, but it's the long-term trends that matter most for the average investor.
Reaching the 5000-point level, albeit briefly, underscores the resilience and potential of the U.S. stock market. For the average person, it's a call to remain informed, diversified, and focused on long-term investment objectives.
For the Savvier Investor…
Fundamental factor models enable the separation of idiosyncratic risk (stock-specific and diversifiable) from systematic risk (market risk and undiversifiable). During my tenure as an Analytics Consultant at MSCI Inc., I have dedicated considerable time to focusing on Global Equity Models, or multifactor models, which consider certain observable factors or characteristics when trying to understand portfolio returns and risk (as measured by the standard deviation of stock price).
We introduce common themes of market phenomena explained by empirical research, such as the historical outperformance of companies with smaller market caps over the long term. Value (often measured by the Book-to-Market ratio) suggests that stocks undervalued relative to their fundamental value exhibit superior performance compared to those that are overvalued. Expanding on the Fama-French Three Factor Model, the momentum factor is introduced, which refers to the tendency of stocks to continue moving in the same direction for a period. Is this relevant to what is happening now? We have observed bullish behaviour in the market since late October 2023, so this factor would suggest that performance is likely to persist into the near future.
…Or should we be wary of other factors, such as short/long-term reversal? This suggests that stock prices can exhibit mean-reverting behaviour over different time horizons. Stocks that have performed exceptionally over the short term (1 week – 1 month) are likely to experience a reversal. This can be explained by an overreaction to recent news or events by investors. Long-term reversal, on the other hand, examines price movements over a much longer period, such as three to five years. It suggests that companies that have underperformed or overperformed over prolonged periods may revert to their mean performance. This can be due to the market's cyclical nature or a change in the company’s fundamentals.
Market movements can be dissected in a million ways, which is what makes them so exciting. It is important to think outside the usual bounds of simple portfolio analysis by country or sector.
Editorial Note: This blog does not constitute financial advise and any information presented here should be used solely for educational purposes. I offer guidance on investing and If you aren’t sure whether investing is right for you, or which specific investments are right for you, please consult an authorised financial adviser.