Episode 500: The S&P 500 Index and the Decade Ahead
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Welcome to Money for the Rest of Us. This is a personal finance show on money, how it works, how to invest it, and how to live without worrying about it. I'm your host, David Stein, and today is episode 500. It's titled, The S&P 500 Index and the Decade Ahead.

We were talking at Money for the Rest of Us, what should we do for the 500th episode? And couldn't really come up with anything because we don't just want to sit back and talk about what we did. We'd rather talk about what's going on now. Brett, though, had the suggestion, well, why don't you talk about the S&P 500 index?

our 500th episode. And that's what we're going to do because there's a lot of elements within the S&P 500, how well it's performed, how it's constructed, where things are, how it might do going forward that very much tie into the themes that we've talked about over the years on money for the rest of us.

I'll certainly talk about the show a little bit, provide some perspective later in this episode, but let's first take a look at the S&P. Standard & Poor's organization was formed in 1941 through a merger of Standard Statistics and Poor's Publishing. The S&P 500, which is a measure of the 500 largest stocks in the U.S. by market capitalization or size, that's

That was launched March 4th, 1957. It was the first index to use a computer-based calculation to track the performance. You need a computer to figure out the weights, which is why earlier indexes, I believe, generally were price-weighted because it was easier to calculate. The Dow Jones Industrial Average, for example, was a price-weighted index. The S&P 500 replaced an earlier 90 stock composite that the S&P had.

Now, if we think back to how the S&P 500 has done since the first episode of Money for the Rest of Us, that was May 16th, 2014. Since then, through yesterday, November 4th, the S&P 500 index has returned 267% QT.

cumulative. That's 13.2% annualized. We're using the iShares Core S&P 500 ETF as a proxy. The measure of outperformance compared to non-U.S. stocks, as represented by the Vanguard Total International Stock ETF, that ETF has returned 4.5% annualized.

In the 10 years we've been doing the Money for the Rest of Us podcast, U.S. stocks have outperformed non-U.S. by more than 8 percentage points annualized. Outside of the U.S., the largest country by market capitalization is Japan, followed by United Kingdom and China. But one of the things that has happened with that strong outperformance is the U.S. stock market has gotten to become a larger and larger percentage of U.S.

the global stock market. For example, in early 2015, the U.S. made up 52% of the MSCI All-Country World Index. This is an index that includes both developed and emerging markets. And at the time, in early 2015, the largest sector in the global stock market was financials at 21%, followed by information technology at 14%.

Ten years later, this is as of the end of October, the U.S. makes up 65% of the global stock market, again, as measured by size or market capitalization. The market capitalization of a stock is the number of shares outstanding times the price. So the U.S. has grown 15 percentage points in terms of the size of its stock market relative to the rest of the world. The

The sectors have also changed. Information technology now comprises 25% of the global stock market, almost double what it was 10 years ago, and financials have fallen from 21% down to 17%.

With U.S. making up 65% of the global stock market, that is the highest weighting since the late 1960s, early 1970s, during what was called the nifty 50 era, where there were 50 very large U.S. stocks that by market capitalization that were dominating both the U.S. market and the

the global stock market. Here's the thing, though. Back in the late 1960s, and this is according to a report by Verdad, which is a weekly newsletter, they're an asset manager. In the late 1960s, when the U.S. made up 60% of global market capitalization, the U.S. accounted for 40% of global GDP, GDP being the monetary value of

So the U.S. made up 60% of the stock market, 40% of global GDP. Now the U.S. makes up 65% of the global stock market, but its GDP weighting is at a six-decade low at 26%. That's a lot of GDP.

That's a bit of a disconnect, unless the market is anticipating that the U.S. economy is going to grow significantly, or perhaps the profitability is much greater in the U.S. That latter point, turns out, isn't correct. In the past year, again, this is according to Gurdad, and this is just developed markets, so we're going to exclude emerging markets. The U.S. makes up 72% of

developed market capitalization as measured by the MSCI World Index. Yet in the past year, only 55% of total net income created was by U.S. firms. 45% was generated by non-U.S. developed market companies. And so if we were basing it on income, the U.S. should potentially have a 55% weight in

the developed market, which would mean it's probably closer to the 50% weight of the overall global stock market, including emerging markets, close to where it was 10 years ago. Before we continue, let me pause and share some words from one of this week's sponsors, NetSuite.

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what has allowed the U.S. stock market to get so much larger relative to other global regions and to outperform by almost eight percentage points. For that, we can do a performance attribution using our stock market research tool, Asset Camp. We have a model on there where we can do a 10-year performance attribution of 46 different stock indexes. We're just going to focus on

on global stocks, including emerging markets, ex-U.S., compared to the U.S. stock market. This is for the 10 years ending October. I also looked at the 10 years ending May, and it was comparable. In that 10 years, dividends contributed 1.8 percentage points to the 12.4% return of U.S. stocks as measured by the MSCI USA Index, which is very comparable to

Earnings grew 7.4%, and combined, that would have still been a solid return of around 9% annualized, which is close to the long-term historical return for the S&P 500. But there was an additional 3.3% annualized.

annualized return contribution from U.S. stocks getting more expensive. The price-to-earnings ratio in the past decade has gone from 19.3 up to 26.7. Meanwhile, for All Country World ex-U.S., that returns 4.8%. Again, about a 7% to 8% point difference. 3% came from dividend yields. Earnings didn't grow as fast, 4.2% earnings growth. The

The valuations didn't really change. So a decade ago, the price-to-earnings ratio of non-U.S. stocks was 15.6. Today, it's at 15.6. But a big drag was currency impact. The U.S. dollar strengthened relative to the rest of the world, and that was a 2% performance drag over the past decade. So just combining earnings and

And the dividend yield, that would have been around a 7% annualized return. So U.S. stocks still would have outperformed if U.S. stock valuation had stayed the same and there was no impact due to currency. It would have outperformed by 2% because its earnings grew faster than the rest of the world. That earnings growth was driven by technology stocks. And that's why technology is now the largest weight in the global stock market, doubling in value.

the past decade. Now, when we think about what was the return of U.S. stocks compared to non-U.S. stocks when the S&P 500 last hit its peak of over 60% of the global stock market, if we take it from its peak at 60% down to its trough, where the U.S. only made up about a

35% of the U.S. stock market in 1988. That was a period where non-U.S. stocks outperformed. Developed non-U.S. stocks returned 15.3% annualized over that roughly 20-year period. The U.S. returned 8.4% annualized.

The biggest outperformer was Japan, 23.8% annualized during that period. And that was a period where Japan had a stock market bubble and became over 40% of the global stock market, bigger than the U.S. in 1988. But then we've had a reversal from 1988 through the end of October 2024. As U.S. has become a larger percent of the global stock market, it's returned 10.5% annualized.

Developed market ex-U.S. returned only 5% annualized, and Japan returned 1.2% annualized. The point is, there are very long-term cycles, and as a country's stock market outperformed, like Japan did in the 1980s, like the U.S. has done in the past decade, those markets become a larger percent of Japan.

the global stock market. And that percentage can be greater than that nation's contribution to global GDP or to global income.

Recently, Goldman Sachs, U.S. equity group led by David Koston, released a new estimate for what they believe the S&P 500 will return over the next decade. Previous decade, it's returned 12 to 13 percent annualized. They say over the next decade, their expectation is an annualized nominal return of only 3 percent.

The range is between negative 1% and 7%. They see about a 72% probability that the S&P 500 will underperform treasury bonds, so lag the bond market over the next decade, and a 33% likelihood that the S&P 500 won't even keep up with inflation over the next decade. Now, on LinkedIn, I used Asset Camp to go through some scenario analysis of

of what would have to happen for U.S. stocks to return 3% over the next decade. It will be a fall in valuations, they get cheaper, or...

or earnings won't grow as fast as they did over the previous decade or some combination. So I'll link to that video in the show notes. And you can see, as we use Asset Camp's expected return model to come up with some reasonable scenarios. Now, we have no idea. But given the high valuations of U.S. stocks, we'll look at here in a few minutes what needs to happen for the U.S. to actually continue to outperform the

the rest of the world. Now, one of the interesting things as we go back 10 years is looking at what were the top 10 holdings of the S&P 500 then back in 2014 compared to today. Surprisingly, the number one holding is the same. Can you guess? It's Apple. But then in 2014, that was followed by Exxon, Alphabet, which is still in the top 10. Exxon is not. Microsoft, still in the top 10. Berkshire Hathaway is still in the top 10. And

And then the following companies are no longer in the top 10 of the S&P 500. Johnson & Johnson, Walmart, Chevron, Wells Fargo, and Procter & Gamble. Now, all of them are still in the S&P 500. They just rank in the teens, in the 20s, and the 30s. If we look at the new top 10, led by Apple at close to 7% of the S&P 500. NVIDIA is also close to 7%. And then we have Microsoft at

at just over 6%. And then that's followed by Amazon, Meta, the two share classes of Alphabet or Google, Berkshire Hathaway, Broadcom, and Tesla. So there's some new additions to the top 10. And you see that change rapidly.

over time. And that's why when we invest, we don't just invest in the top 10. We want to get broad diversification of the U.S. market as measured by the S&P 500 or even broader, including small and mid-cap. But we also want some global stock exposure. Before we continue, let me pause and share some words from this week's sponsors.

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Now, if we look at those top two holdings, Apple and Nvidia make up close to 14% of the S&P 500. Last month, the S&P changed their methodology in terms of how big any one company or group of companies can get of S&P.

any S&P stock index, including the S&P 500, or it could be, and this is more relevant to sector ETFs, the new rules that were put in place is that no company can be greater than 24% of the index. And so if it reaches 23%, there needs to be some of the additional allocation is spread among the other companies. And then S&P 500,

At the same time, those companies that have a greater than 4.8% weight in the index, the sum of those companies with essentially more than close to a 5% weight can't be greater than 50%. Now, again, if we look at with the S&P 500, there's only three companies with weights greater than 5%, Microsoft, NVIDIA, and Apple, and combined, Microsoft,

they make up about 20% of the index. If the S&P became even more concentrated in the top names, those greater than approximately 5% couldn't make up more than 50%. And if so, then they would have to be redistributed, those weightings. Now, this applies more to a sector ETF. Okay.

Because there, let's say a technology sector, you could see that. And S&P rebalances quarterly, or they look at this quarterly to see if there needs to be any redistribution. Asset managers like this idea. I mean, they did this in discussion with ETF managers to sort of reduce some of the concentration in some of these indexes. But right now, it doesn't really impact the S&P 500. A different thing that is impacting asset managers...

and Vanguard recently disclosed this in some of their prospectuses, is any one asset manager can't own more than 10% of the outstanding shares of a bank or utility. And BlackRock iShares and Vanguard, they've exceeded that 10% cap and they've requested an exception and they're

They've gotten it. They've gotten that relief. But now Vanguard in their recent disclosure said it's not always possible to secure relief. And there is an increasing amount of uncertainty about how much ownership limitations relief regulators will grant to asset managers like Vanguard. We did an episode a year ago that I'll link in the show notes about...

is Vanguard and BlackRock getting too big? And they have gotten so big that they're having to ask for relief by having too much in any given bank or utility. And there's been criticism of Vanguard and BlackRock by both sides of the political spectrum relative, they're getting too big or too political. So that's what's going on with the S&P today. It's valuations, it's historical returns.

how the makeup changes over time. We've seen that Goldman Sachs has a 3% expected return. If that happens, it'll be a function of lower valuations and lower earnings growth. When we think about what will drive the

the level of outperformance of the U.S. stock market versus the rest of the world, it's very much the things that we talked about in episode 499. What makes a nation prosperous? The U.S. could continue to outperform if the level of uncertainty here is less than other areas. That includes geopolitical developments, the potential impact of climate change, and some of these issues

are the same issues we talked about in episode 281 on four forces that could shape the next decade. That episode was released in December 2019. But geopolitical developments, climate, especially as it relates to insurance premiums, for example, water-related natural disasters, wildfires due to drought, that could impact the return of the U.S. market and other markets around the world. So the

to the level of uncertainty. An outperforming country needs a growing, educated workforce. Having a growing workforce means that there's higher GDP growth, more output. More output trickles down to higher earnings growth, which is a major driver of the outperformance of U.S. stocks over the past decade. Now, it was a more educated workforce because that leads to productivity improvements. The ability to produce more have

have greater corporate profits with less inputs or less cost. One of the biggest developments in the past decade, really the last couple of years, is AI and the potential for artificial intelligence, including large language models, that impact on earnings and productivity improvements.

That's one reason we've had this significant valuation increase and shift to technology making up double the weight of the global stock market than it did a decade ago. It's the potential promise and hope of AI. And will it lead to higher profits for both the AI-related companies, but the overall stock market due to greater productivity increases?

Now, there's also demographic headwinds that we've talked about around the world, including the U.S., and as a result, the ability of a nation to continue to grow the workforce with India leading the way there or to be receptive to more immigration, to import workers if the birth rate within the country is falling.

Another impact of whether the U.S. will continue to outperform will come down to monetary stability. The U.S. dollar strengthened over the past decade. That strengthening caused non-U.S. stocks, as quoted in dollars, to lag by an additional 2%.

Will the dollar continue to strengthen in the decade ahead? There are certainly long-term cycles. Currency will be impacted by uncertainty, geopolitical risk, but also national debt dynamics, budget deficits, the amount of money creation, the level of inflation. I've talked a number of times how the money supply in the U.S. increased 40% over the past few years, and that contributed to debt.

the inflation, and that clearly has geopolitical impact. So monetary stability will influence which country will outperform over the next decade. And then trade. Will there be more tariffs? Will the U.S. continue to run such a huge current account deficit in the same way Argentina did and got into trouble and now is correcting that? The U.S. continues to run a huge current account deficit, which is a huge

which means they need to continue to figure out a way to finance that by households and businesses borrowing money to buy all those imports, or the U.S. government continued to run a huge budget deficit to help finance it by then increasing the national debt. And we'll see

as we looked at in the three-part series earlier this year on the national debt, where interest rates will go. Will the nominal interest rate on the U.S. debt continue to be lower than the rate of

of nominal GDP growth. And if it does, then the debt potentially won't get completely out of hand, but that's a big unknown in the decade ahead. And then a final thing is just trust. Where will the trust be in institutions, including the media, and interpersonal trust among neighbors and among people we disagree with? We're halfway through the decade, or almost halfway, and those forces have impacted.

To date, in the first five years, the U.S. stock market continued to do very well as it has over the past decade. But we'll see. Will the S&P only return 3%? Will non-U.S. outperform if U.S. valuations fall? Today is election day in the U.S. The S&P released a report and said in election years, the S&P 500 rose 79% of the time with an average gain of

of 6.8%. This was since 1945. In all years, including election years and non-election years, the S&P rose 71% of the time. In most presidential election years, the S&P was positive as it has been year to date. He also pointed out that if the S&P has a positive return in election year from July 31st to October 31st, the

The party controlling the White House won the election 82% of the time.

If the S&P loses ground between July and October, the party controlling the White House lost 89% of the time. The S&P 500 has returned 3.7% this year from July to October. So based on historical data, that suggests that the Democrats would win this presidential election. Except there's only been 20 elections since 1945, 20 data points, so that we would need...

A long, long more time for this to be statistically significant. But we'll see. Hopefully we'll come out of this election cycle, the ability just to rebuild trust.

These are part of the whole geopolitical risk and trust that will impact U.S. stock returns in the decade ahead, along with the other factors that we've talked about. Monetary stability, increased productivity, will the promise of AI come through? That's our discussion on the S&P 500. Thank you for being a part of our journey.

money for the rest of us. I use AI not to write scripts for the podcast by any means, but I find ChatGPT a useful tool to just kind of go back and forth with on a number of different topics, never actually trusting what it says at the end, always confirming. And I asked it, what are 10 themes that we have discussed over the past decade on money?

money for the rest of us. And this is based on what ChatGPT did. Now, it searched the web, it searched podcast episodes from Apple, Spotify, it searched our topic index on the website, and now at least they put the sources. And here's...

Ten, not in any particular order, but understanding money's mechanics, how money functions within the economy, including fiat currencies, inflation, the roles of central bank. That's definitely been a theme. Diversification in investing. We don't spend a lot of time talking about individual stocks. We talk about asset classes and diversifying. ChatGPT says we talk about behavioral finance awareness, recognizing the psychological factors and emotions can influence our decisions.

decision-making, long-term investment perspective, risk management, economic indicators and trends, retirement planning strategies, financial independence and freedom, critical evaluation of financial products. We've looked at a number of products most recently. This year, we've looked at covered call strategies and defined...

outcome ETF or buffer ETFs and continuing financial education. There's also philosophical discussions we've talked about, contentment versus consumption, risk and uncertainty, time and impermanence. And those are things we'll continue to talk about on the show. We're going to continue to release new episodes of the podcast each week. I still enjoy it after a decade. I learn a ton and

as I produce the podcast. Perhaps we'll do more interviews. I have an interview scheduled for later this week, but we'll just see. No promises, but thank you for listening. Thank you for sharing the show with others and for being part of this decade-long journey. This is episode 500 of Money for the Rest of Us. Thanks for listening.

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